Submitted by David Stockman via Contra Corner blog [15],
That was quick! Last November Snapchat was valued at $2 billion in the private VC market; by Q1 that had risen to $7 billion; and yesterday it soared to $10 billion. Gaining $8 billion in market value in just nine months is quite a feat under any circumstance - but that’s especially notable if you’re are a company with no profits, no revenues and no business model.
And, yes, that’s not to mention the “product”, either. Apparently, Snapchat’s 100 million teenage and college users mostly swap pics of their private parts which vanish after 15 seconds - or so they think. In that respect, Snapchat’s business challenge may not be lack of “demand”, but whether its exhibitionist “customers” will be copasetic with sharing their 15 seconds of fame with advertisers.
Time will tell, unfortunately. In the meantime, however, its evident that Snapchat’s spectacular valuation rise is not about how to discount the potential value stream from monetizing dirty pictures. Instead, it reflects the crazy dynamics of late stage financial bubbles. And on that score, Wolf Richter has hit the nail squarely on the head, as usual.
As he explains in today’s post, Snapchat’s spectacular valuation run-up is just a new and more sophisticated form of “pump and dump”. In this instance, the venture capital firms involved have apparently invested trivial amounts of chump change in the two recent funding rounds in order to peg dramatically higher paper valuations in preparation for an imminent IPO. In numeric terms they have invested less than $30 million since last November, meaning that they have been able to leverage an $8 billion valuation gain at a ratio of 266:1.
By strategically deploying less than $30 million, KPCB, and DST Global before it, have ratcheted up Snapchat’s valuation from $2 billion to $10 billion. With the stroke of a pen, in a deal negotiated behind closed doors, they have created an additional $8 billion in “wealth” that is now percolating through the minds of employees with stock options and through the books of the early investment funds.
To be sure, Wall Street has sponsored such market-rigging ploys since time immemorial. However, the true evil of rampant central bank money printing is that it vastly enables and amplifies such speculative ventures, while at the same time eviscerating the natural checks and balances against speculative manias which are embedded in honest financial markets.
Specifically, zero money market rates (ZIRP) for 68 months running have unleashed carry trade gambling in the financial markets like never before. That’s because professional Wall Street speculators can acquire risk assets and “fund” them on high leverage— through margin accounts, options trades or specifically crafted “structured finance” deals from their prime brokers—- at tiny interest rates. The resulting “spread” is bubblicious—especially when the Fed’s implicit “put” under the stock averages fuels a rambunctious “buy the dips” psychology among traders.
Under those circumstances—which are rampant at the moment—a gambler’s wildest dream comes true. The carry cost side of a leveraged gamble is pinned at close to zero by the solemn commitment of the central bank, while the asset value side of the trade ratchets ever higher owing to the endless bid of the dip buyers.
And its actually even better. The obvious effect of the Fed’s incessant market coddling since at least the days of the LTCM bailout in September 1998, but especially since Bernanke went all-in September 2008, is that the natural short interest in the stock market has been punished, bloodied, and destroyed. Consequently, downside insurance on speculative portfolios (i.e. puts on the S&P 500) is dirt cheap, meaning aggressive traders can protect themselves against an unexpected (and unlikely) plunge in the broad market while barely denting their gains from high flying momo stocks in favored sectors like social media or whatever happens to be the flavor of the week.
Needless to say, cheap downside insurance only enlarges and strengthens the bid for high flyers—-a dynamic that works wonders in the IPO market, especially. Accordingly, lunatic valuations have once again flourished in the new issues market as if its 1999-2000 all over again.
And like then, the resulting devil’s workshop environment incentivizes the smart money to concoct schemes to exploit the bubble—like yesterday’s 266:1 leveraging of Snapchat’s valuation. That this will end in tears for the “slow money” IPO sheep who show up for the shearing, goes without saying.
What needs remark, however, is the enormous damage that these kinds of financial deformations and distortions do to the real economy and the capitalist machinery of invention and enterprise. By all the historic evidence, Kleiner Perkins has been one of the greatest incubators of technological progress and business innovation in modern times. Surely it has better things to do, therefore, than run a crude 1920s style pump and dump scheme that will contribute nothing to society except painful losses for the retail investors who take the bait.
So here’s the thing. Free central bank money corrupts free markets absolutely—-that should be more than evident by now. But owing to the dense economic fog on her Keynesian windshield, Janet Yellen and her band on money printers in the Eccles Building remain clueless as to the monumental corruption that is being injected into financial markets by Fed policy.
Would that Yellen should at least read Wolf Richter’s excellent post on the present moment’s most spectacular example of that. Better still, perhaps a trip back to San Francisco where bubble opulence ricochets thru the entire economy would be in order. She might discover that the median housing price has soared to more than $1 million; and that none of the inhabitants of the “labor market” that she is so vainly attempting to revive even qualifies for a standard mortgage.
By Wolf Richter At Wolf Street [16]
How much does it cost to manipulate an entire market? Not much. And it’s getting cheaper!
It was leaked on Tuesday by “people with knowledge of that matter,” according to the Wall Street Journal, that VC firm Kleiner Perkins Caufield & Byers had decided in May to plow up to $20 million into message-app maker Snapchat, for a tiny portion of ownership. An undisclosed investor also committed some funds. The deal, which apparently hasn’t closed yet, would give Snapchat a valuation of $10 billion.
That’s a big step up from November last year, when the valuation was $2 billion. At the time, the company had raised $130 million in three rounds of funding. By now that would be closer to $160 million, after it was also leaked that Russian investment firm DST Global had put some money into it earlier this year, boosting its valuation to $7 billion at the time, once again, “according to two people familiar with the matter.”
At a valuation of $10 billion, it joins the top of the heap: app makers Uber ($18.2 billion) and Airbnb ($10 billion), cloud storage outfit Dropbox ($10 billion), and Palantir, the Intelligence Community’s darling ($9.3 billion).
Unlike the others in that group, Snapchat is marked by the absence of a business model and no discernable revenues. But there is hope that it could eventually pick up some revenues by advertising to its 100 million or so users, mostly teenagers and college students, without turning them off.
But in this climate, no revenues, no problem. Into the foreseeable future, the company will produce a thick stream of undisclosed red ink.
But the investment was an ingenious move.
For KPCB, a huge VC firm, the investment would amount to petty cash. Why did it do this deal? If it could exit at an enormous valuation of $20 billion, it would only double its money – a paltry multiple, given the risks. It would only make $20 million, still petty cash. But there was a reason….
By strategically deploying less than $30 million, KPCB, and DST Global before it, have ratcheted up Snapchat’s valuation from $2 billion to $10 billion. With the stroke of a pen, in a deal negotiated behind closed doors, they have created an additional $8 billion in “wealth” that is now percolating through the minds of employees with stock options and through the books of the early investment funds.
Snapchat’s new valuation isn’t an isolated event. It’s a product of all recent valuations, and it is itself now ricocheting around and is used to set the valuations at other startups. That’s the multiplier effect. What seemed like an absurd valuation yesterday becomes the norm tomorrow, on the time-honored principle that once a valuation is already absurd, it no longer faces resistance from any rational limit. And nothing stands in the way for the multiplier effect to ratchet valuations ever higher.
Nothing, except the potentially troublesome exit for these investors. Because, without exit, these paper gains will remain paper gains, and eventually will disintegrate into dust.
To exit gracefully, investors can sell the company via an IPO mostly to mutual funds and ETFs that are stashed in retirement funds and investment portfolios. Or they can sell it to giants like Facebook or Google that can pay cash (borrowed or not) or print their own currency by issuing shares, both of which come out of the pocket of current stockholders. At the far end of both transactions are mostly unwitting retail investors.
Inflating Snapchat’s valuation by $8 billion with a few millions dollars rigs the entire IPO market that depends on buzz and hype and folly to rationalize these blue-sky valuations. Unnamed people “knowledgeable in the matter” who leak these valuations to the Wall Street Journal [17] are an integral part of the hype machine: It balloons the valuations of other startups. And it creates that “healthy” IPO market where money doesn’t matter, where revenues and profits are replaced by custom-fabricated metrics.
The hope is that the IPO market remains “healthy” long enough for investors to be able to unload hundreds of these companies at crazy valuations. The hype surrounding these valuations is creating more enthusiasm about IPOs in a self-reinforcing loop. The hope is also that the broader stock market continues to soar so that potential acquirers can print more overvalued shares to acquire more overvalued startups so that the exists can come about. Under the motto: after us the deluge.
The deluge will wash over retail investors.
While it’s possible that one or the other startup might become the next Facebook or Google, there are only a few Facebooks and Googles, but there are many startups whose business model and permanent lack of profits will eventually bring them down to reality, either in the portfolios of retail investors, or as a write-off by the acquirers, whose shares are also stuffed into the nest eggs of retail investors. Along the way, Wall Street extracts fees from all directions. That’s the Wall Street money transfer machine. It smells like a rose when all stocks go up, but when the tide turns…. OK, that won’t ever happen.
With fundamentals and economic realities having become totally irrelevant these days, economists are reassigned to tout stocks. Read…. Economist: Stocks No Longer Risky, Will Go Up ‘Steadily’ [18]
