Each month at Northwood, we gather the partners, client team and investment team together for our monthly investment meeting. This meeting has a variety of purposes. It’s a chance to review the performance of our preferred investment managers and their relative benchmarks, discuss trends that we’re seeing in the market, and update the group on any investment related client questions that have come up recently. As the firm grows, it is also a chance to get a large group of us in the same room (or at least on the same conference call!) on a monthly basis. The discussions are always interesting, and I often learn something new that I can pass on to clients at a future meeting.
At a recent meeting, we discussed several pieces of evidence that each seemed to suggest that the market has gone insane. Someone suggested that these pieces of evidence would make a good newsletter article, and you are now reading the results of that comment. Without further ado, here are two illogical trends that we have seen in the markets over the past six months, and the future outlook for both of them.
1. Negative Interest Rates
A recent Bloomberg article began with the following sentence; “Negative interest rates have quite literally broken one of the pillars of modern finance.” The author was referring specifically to traders inability to input negative numbers into their risk models, but I think it also speaks to a broader issue. We have become so accustomed to the idea of positive interest rates in our society, that the concept of negative interest rates is hard to fathom for many of us. Beyond their unfathomability, I’ve also yet to find a single person (finance professional or not) who thinks that negative interest rates are a good idea or make sense in the long term for our market based financial system.
A quick refresher for those whose eyes glazed over during the previous paragraph. Negative rates mean that a country’s central bank (and in many cases private banks) will charge negative interest. What this means practically is that you deposit money at the bank, and instead of earning interest on your savings account as you did in the past, the bank charges you a fee to hold your money. This phenomenon has not yet come to North America, but is currently in place in Japan and many European countries. Of course, the negative interest rate phenomenon can cut both ways for banks. A Danish bank recently generated international publicity by launching the world’s first negative interest rate mortgage. Jyske Bank agreed to charge minus 0.5% per year on 10 year mortgages, which means that before taking other fees or charges into account, homeowners in Denmark would be paying back less than they borrowed from the bank in the first place.
With approximately $15 trillion in sovereign debt now trading at negative rates, the Bank for International Settlements recently described the growing acceptance of negative interest rates as “vaguely troubling”. Despite this warning, and the general consensus that negative interest rates don’t make much sense, it seems these numbers have the potential to grow in the short to medium term. President Trump has openly called for negative rates in the US via Twitter, and macroeconomic headwinds could lead other countries down a similar path.
2. Unicorns and Their Valuations1
Although there is no happy ending in sight to the conundrum of negative interest rates, the recently aborted IPO of WeWork, and its knock-on effects in private and public markets, provides hope that sanity can return to the investment world. The WeWork story has been covered elsewhere, most notably by NYU Professor Scott Galloway, but I think it’s worth discussing the overall landscape for tech companies, and just how much it has changed in the last six months.
Until recently, the venture capital investment firms who funded Silicon Valley’s ‘Unicorns’ have embraced and rewarded a growth at all costs model. It didn’t matter if these companies were losing billions of dollars per quarter. As long as they were growing topline revenue, the valuations would continue to go up in each subsequent fundraising round. This left founders such as WeWork’s Adam Neumann, and Uber’s Travis Kalanick, with billions of dollars of venture capital money to spend on acquiring market share, growing revenues and attempting to justify their stratospheric valuations.
The air had already started to go out of this bubble before WeWork announced its ill-fated IPO in August 2019. For example, Uber’s IPO was pitched by Wall Street banks in March 2019 at a valuation as high as $120B. By the time the unprofitable company actually went public in May, the valuation was down to $82B. Since then, the stock price is down another ~35%, bringing the overall company’s value down to $50B. Keep in mind, this is still a massive valuation for a company that lost more than $5B in its most recent quarter, and has not outlined a realistic future path to profitability.2
Uber and WeWork are not alone in the list of unprofitable companies that have gone public in 2019. Uber’s main competitor Lyft is down more than 45% from its IPO price, and Peloton, the company that sells internet-connected stationary bikes for $2,000, has seen its stock price drop by almost 20% since going public last week.
All this evidence seems to point to an investment market that is coming to its senses when it comes to tech company valuations. At the end of the day, it doesn’t matter how fast you can grow topline revenue if you are losing money to do so. Perhaps the market of the future will put a higher premium on profitability (or at least a realistic path to profitability), and less of a premium on breakneck growth.
1 Coined by venture capitalist Aileen Lee in 2013, a ‘Unicorn’ is a private company with a valuation of $1B or more.
2 For the full story on Uber’s rise and fall over the last ten years, I’d strongly recommend the recently released Super Pumped: The Battle for Uber by Mike Isaac.