Can’t See The Forest Through The Trees

In a certain light, Uber Technologies Inc.’s valuation peaked last fall when investment bankers pitching to underwrite its initial public offering told Uber that it could be worth $120 billion when it went public. That was not a firm offer or anything, just a number that they wrote down in their pitchbooks, but at least it was a big number. By the time Uber actually filed to go public, the rumored valuation was down to $100 billion, and it launched the IPO late last month with a price range of $44 to $50 per share, or a market capitalization of up to $84 billion.

This was a little disappointing: Even the high end of this range was barely above the per-share valuation that Uber had gotten in its recent private funding rounds. But Uber’s banks telegraphed that the range was meant to be conservative after competitor Lyft Inc.’s disappointing IPO, and anyway you can always raise the price range if demand is strong. Presumably the intention was to use the bargain pricing to get a lot of orders, build a strong book of demand, and then push the price range up. And then the banks rapidly put out noises about how there was plenty of demand for shares in that price range, and indeed, enough demand to price the IPO at the high end of the range. But, they hinted, they would not be raising the range: After Lyft Inc. raised its price range and saw its stock drop after the IPO, Uber wanted to be conservative and price within the range. Then it leaked that Uber would price not only in the range, but at the midpoint of the range.

Then it actually priced towards the low end of the range; the IPO priced at $45 on Thursday evening. Then the stock cracked immediately and kept going down. It opened the next morning at $42, and never got above the IPO price; it closed at $41.57 on Friday, and fell below $40 this morning. Today’s opening price was $38.79, for a market capitalization of about $65 billion. Since its (entirely hypothetical) peak in October, Uber has lost almost half its value.

Oops. Pitching a high valuation and then launching at a conservative one to build demand is a standard part of the capital-markets playbook, but at some point it’s supposed to turn around. Pitch at $120 billion and launch at $85 billion, fine, but then price at $90 billion and have it trade up to $110 billion on the first day. That’s normal. The steady slide downward is a mistake.

But the underwriters are not alone in getting it wrong. For years now, Uber’s investors seem to have overestimated the value of its stock. “Apart from SoftBank, every new shareholder who bought Uber’s IPO stock or purchased shares privately in the last three years is underwater on their investment,” notes my colleague Shira Ovide. The going rate for Uber stock in private capital raises for the past three years has been $48.77 per share. In the public market, as of 11 a.m. today, it was less than $38. The public market is about 20% less optimistic about Uber than the private market was.

Why? Part of it is timing; the broad market fell during the week leading up to Uber’s IPO pricing, and IPOs are very sensitive to market conditions. This is not a particularly satisfying answer; the S&P 500 index was down about 2.4% between the beginning of Uber’s roadshow and the time it priced, but it was up about 36.5% between December 2015, when Uber first sold shares for $48.77, and the IPO pricing. The stock market had a rough week but a decent three years; Uber has had a rough three years.

Part of it might be structural differences between public and private markets. Private markets don’t give you real-time value measures, and so they can inflate valuations: You raise money when demand is high, printing a high valuation, and then if demand cools you just don’t raise more money and there’s no evidence of a lower price. (In fact, when it was private Uber did do a weird deal with SoftBank Group Corp. that sort of gave it a lower value than the $48.77 per share that it was getting in fundraising transactions.) If the stock trades all day, then you get a minute-by-minute account of sentiment, which is currently grim.

Also, public markets have short sellers and private ones don’t, which means that private companies’ prices are set only by their enthusiasts while public companies’ prices are set by their critics too. You shouldn’t overestimate this — in the first few days after an IPO there isn’t usually much short selling — but it has some effect. It’s exacerbated in Uber’s case by the fact that pretty much anyone who was enthusiastic about Uber was able to buy shares a long time ago: The shares have traded on secondary markets and been offered to mutual funds, hedge funds and rich individuals for years now, so there wasn’t really anyone left to buy the new shares in the IPO. There wasn’t enough new supply of enthusiasts rushing into Uber’s stock to offset the critics.

But there is also a long-running story about the unicorn economy in which venture capitalists are happy to throw money into unprofitable business models to chase growth, and public markets aren’t. This is a popular stereotype, and of course not entirely true, but Uber’s unhappy debut does tend to support it. I wrote recently:

We have talked, a couple of times, about why the venture capitalists might care about growth and not profits, with possible answers including (1) they correctly believe that in the long run rapid growth will lead to monopoly profits, (2) they incorrectly believe that, (3) they are just nice or (4) they are trying to forestall socialist revolution by giving people cheap stuff.

The underwater Uber IPO is a data point for option (2). For about three years — up to and including last Thursday — investors threw money at Uber, which it used to subsidize car rides, and none of those investors have gotten a return on their investment. Instead there have been cheap car rides. Maybe one day they’ll get a return! But it’s been a rough three years.