Monday, March 7, 2016

Matt Levine On Unicorns

From BloombergView:

Unicorns Aren't So Beloved Anymore
The way a bubble works is, people get enthusiastic about a thing, so they buy a lot of it, and its price goes up.  Then people realize the price is too high, so they sell a lot of it, and the price goes down. All of your favorite market things -- supply and demand, buyers and sellers, the price mechanism -- get a workout. It is a good time, unless you bought the thing near the top.

Today's Wall Street Journal has a terrific story about how mutual funds that bought stakes in large closely held technology companies are now writing down some of those stakes:
BlackRock Inc., Fidelity Investments, T. Rowe Price Group Inc. and Wellington Management run or advise mutual funds that own shares in at least 40 closely held startups valued at $1 billion or more apiece, according to securities filings analyzed by The Wall Street Journal.
For 13 of the startups, at least one mutual-fund firm values its investment at less than what it paid, the Journal’s analysis shows. Those firms are valuing the 13 companies at an average of 28% below their original purchase price.
One way to read this story is that there was a unicorn bubble and it popped. But it has played out, as it were, without markets -- or at least, without market trading of those unicorns' shares. (At least, on the way down.) Instead, the mutual funds' portfolio managers got enthusiastic about unicorn shares, so they bought a lot of them, and their prices went up. And then the mutual funds' valuation committees realized that the prices were too high, so the prices went down. Selling wasn't required: The committees just decided on the price, and that was the price.

I mean, it wasn't exactly the price. A mutual fund valuation committee's decision that, say, Zenefits is worth 30 percent less than it was a few months ago doesn't necessarily mean that anyone bought or sold shares at the new lower price. But in other ways, those numbers really are performing the functions of a price mechanism. For instance, lower "prices" are telling investors to allocate less capital to unicorns:
No U.S.-based, venture-backed technology companies have gone public so far this year. Last year, 16 such companies had IPOs, down from 30 in 2014. Their shares had fallen more than 30% on average as of mid-February.
The suffering stock market is likely to keep the IPO pipeline shut to companies that previously raised capital at lofty valuations and don’t want to go public at a lower price.
And the big mutual fund companies in the story -- Fidelity, T. Rowe Price, BlackRock, Wellington -- are themselves making fewer startup investments than they did in previous quarters. The regular workings of the price mechanism are unnecessary: You don't need buying and selling; pure abstract contemplation by committees at investment firms is enough to create a market price. Economists have long debated how prices could be set and resources allocated by a central planner without the use of market mechanisms to signal demand. This is called the socialist calculation problem,  and it is pleasing that late-stage unicorn capitalism has solved it.

I mean, I kid, a little. These prices are based on market transactions...MUCH MORE