"There Has Been A Remarkable Number Of Blow-Ups In Recent Months"

Submitted by Nicholas Colas of DataTrek Research

For an equity market at near all-time highs, there’s been a remarkable number of important blow-ups in recent months: WeWork, Uber, Lyft, Tesla/Nio, Netflix, marijuana stocks, vaping, and crypto currencies all come to mind. That’s important, because these are all “platform” companies/products – the exact business model that has driven significant increases in stock market value over the last 5 years. Let’s hope 2019 is just a bump in the disruptive road, because we need more of this sort of innovation. Not less.

Let’s start with some examples:

#1: WeWork, which was supposed to remake the concept of office space/leasing, had to pull its IPO, fire the company’s founder from his CEO slot, and now faces an unexpected capital crunch.

#2: Uber and Lyft, which were billed as the future of mobility, did manage to IPO but their stocks are now 30%/43% below their issue prices.

#3: Tesla and Nio, 2 pure play public electric car companies, are down 31%/70% respectively this year with deeper-pocketed conventional rivals (e.g. GM and VW) fully committed to selling EVs at a loss for the foreseeable future.

#4: Netflix, once a go-to name to get investment exposure to the cord-cutting trend, is down 33% from its June 2018 highs. As with Tesla/Nio, there’s plenty of new competition in the streaming space, many at lower price points.

#5: Marijuana stocks, which ride investor perceptions on both the future of legalization and a range of potential new uses for the plant, currently trade right where they were in early 2016 and are down 46% from their September 2018 highs.

#6: Vaping has gone from hero to near zero, with Juul’s valuation dropping from where Altria invested ($38 billion) to “pick a much lower number” today, scuttling the MO-PM merger in the process.

#7: Bitcoin was seemingly on the path to redemption this year, but has been rolling over hard in the last week, down 23%. That’s a big drop, even for that asset.

Now, the easy explanation here is that all these are examples of capital markets mispricing, bursting bubbles one and all. The ingredients that go into investment manias are certainly all there: groupthink, focus on price momentum over fundamentals, and belief in the “greater fool”.

  • Venture capital drank too much of its own Kool-Aid and thought public markets would embrace chronically money-losing businesses with fuzzy plans for future profitability.
  • Equity investors embraced charismatic founder-CEOs, buying into a vision of huge upfront investments for disruptive technologies while dismissing the idea that established competitors could create their own compelling offerings.
  • Younger investors’ naïve belief that their own vision of the future would arrive promptly and with few detours.

That’s a perfectly good rearview mirror take, but let’s focus on what really matters: future equity returns. Here’s the problem in a nutshell:

#1: When it comes to “platform” companies, venture capital has done a generally terrible job building these businesses into viable companies. WeWork, Uber and Lyft raised a combined $43 billion from VCs. Yet for all that capital, none of these companies developed a business model that could reliably generate profits or even show meaningful progress to that goal without a deus ex machina innovation like self-driving cars.

#2: Electric/autonomous vehicles, vaping, marijuana and bitcoin have theoretical value because they are “platforms”: scalable products and services that can disrupt entrenched competition ranging from user-owned vehicles to financial services.

#3: Public equity markets need vibrant, growing platform companies to create long-term value for investors, as the last 5 years clearly shows. Some examples:

  • Tencent: Chinese gaming/music/social media platform. $410 billion market cap, +186% over the last 5 years on a price basis.
  • Alibaba: Chinese ecommerce platform. $456 billion market cap, +99% over the last 5 years.
  • Apple: global smartphone platform. $998 billion market cap, +121% over the last 5 years.
  • Google: global search/advertising platform. $863 billion market cap, +117% over the last 5 years.
  • Amazon: global ecommerce platform. $863 market cap, +440% over the last 5 years.
  • Facebook: global social media platform. $514 billion market cap, +132% over the last 5 years.

#4: The problem is that, with the exception of Google, every one of these companies’ stocks peaked a year ago or even further back. Incremental regulatory scrutiny combined with their already super-sized market caps may well limit further upside. It is therefore hard to see these stocks compounding at 23%/year – their average 5-year historical returns – over the next half decade. And remember that the S&P 500 has only compounded at 9% over the same time frame and owns all the US names on our list.

Summing up: the old saw about stock markets discounting future earnings will always be true, but over the long term the companies that create those profits change. In a global, tech-enabled world, platform companies and products have the best chance to create sustainable cash flows and future shareholder value. Hopefully this year’s spate of failures is just a bump in the road, and history says it should be. But it is a worrisome development nonetheless.