How we should bust an investment myth

The largest casualty of We Co.'s deferred initial offering, the parents of WeWork's office-sharing business, is not the company or its bankers. It is the myth that private markets are superior to public markets.

Investors have long been told that the stars of the financial universe are hedge funds, venture capital and private equity managers. These supposedly visionary geniuses are said to be immune to the short-term thinking that gives poison to the public markets. The investment horizons should be longer, the risk lower, the return higher.

Since 2008, pension funds, university grants and other giant investors have poured about $ 2 trillion in private vehicles on that promise. Some investors have rarely been allowed past the velvet rope ̵[ads1]1; but as We debacle shows, it's not always a bad thing.

Not long ago, we valued venture capital backers at $ 47 billion. The proposed IPO wavered as public investors signaled they would not value the company well over $ 15 billion – suggesting that the allegedly sophisticated private market had priced. We have about three times what it's worth.

Second Opinion

Unicorns often fall in value when published, although We Co.'s potential decline is significant.

Unicorns who got a haircut in stock exchange listing

Valuation at the end

venture-capital round

Latest estimate of We & # 39; s public market valuation:

$ 15 billion

Valuation at VC- round in January:

$ 47 billion

Unicorns who got a haircut in their stock exchange listing

Valuation at last

Venture capital round

Estimate of We & # 39; s public market values:

$ 15 billion

Valuation at the VC round in January:

$ 47 billion

Unicorns who got a haircut in their stock exchange listing

Valuation at the end

Venture capital round

Latest estimate by We & # 39; s public market valuation:

$ 15 billion

Valuation at the VC round in January:

$ 47 billion

Unicorns who got a haircut in their stock exchange listing

Finally valuation

venture final round

Latest estimate for valuation of the public market:

$ 15 billion

Valuation at the VC round in January:

$ 47 billion

We monarchical executive perks, unorthodox accounting and cunning management style seemed almost to confuse the private market investors. The company lost nearly $ 1.4 billion in revenue of $ 1.5 billion in the first half of 2019. Public investors found none of the fun.

No wonder, in a video conference earlier this week, we were the founder and CEO,

Adam Neumann,

told employees that the company has "played the retail market game to perfection," as my colleague Eliot Brown reported. Public markets, he added, were a different story.


What have you experienced with private versus public markets? Join the conversation below.

A spokesman for We declined to comment. However, Neumann's comment shows how hollow the narrative of private market superiority is. They may be more prone to error than public markets are – no less.

The markets work best when they are both deep and wide, integrating sharp differences of opinion from many people at a price that investment can trade.

However, private markets are shallow and narrow, despite their enormous size.

Unregistered securities offerings totaled $ 3 trillion in 2017, the Securities and Exchange Commission estimates – twice the public offering of equities and bonds.

Yet in these club circles – unrealized real estate, infrastructure portfolios of airports and highways, venture capital that nurtures start-ups and private equity funds that buy entire companies – relatively few investors decide which investments are worth, often based on similar views. Short sales, or to bet that prices will fall, do not exist.

"Normal markets consist of pessimists, neutral people and optimists, who can take each side of a trade so that the price can settle with some kind of equilibrium," said Michael Mauboussin, director of research at BlueMountain Capital Management LLC, an investment firm in New York. "But that is not the case in a private market where it is difficult to sell and pessimists cannot easily express a view."

Expectation against reality

Unicorns whose IPO valuations were lower or higher than the valuation given at their last VC round

So far this year,

had two of 14 unicorns

made public [19659030] haircut

So prices are first and foremost for optimists.

According to PitchBook Data, 66 companies valued at $ 1 billion or more have made initial public offers from 2011 to mid-September 2019. One-third of these IPOs came at prices below the value set in the companies' last round of private financing.

Bloom Energy




Reata Pharmaceuticals



all launched listed prices priced at least 40% lower than the valuation in the final private financing round, according to PitchBook.

Perhaps this is because conventional valuation methods can exaggerate what private fund venture positions are worth. Often several stock classes are valued equally, although they are not all entitled to the same payouts.

Or maybe the brilliance in the private market is exaggerated. Consider a recent survey of nearly 900 venture capitalists.

Asked if they "often make a gut decision to invest" in an innovative company instead of relying on analysis, 44% of the company's executives in the venture fund said yes.

What financial metrics do they use to analyze investment? "None," admitted 9% of those polled. Only 11% quantitatively analyze past investment performance. A similar survey of private equity executives found that they "do not often use" methods that are standard among public investors to discount future cash that the equity stake can generate.

More from The Intelligent Investor

Are "unicorns" – that these startups are already worth more than $ 1 billion in the private market – overvalued? Yes, said 91% of venture capitalists who have no unicorns in the portfolio. And yes, 92% of VCs said .

No one disputes that when private investment pays off, it pays tremendously. But the gap between the best and the worst is huge. And on average, over time, they tend not to outperform public markets by large margins – especially when adjusted for risk, the promise that borrowed money can give and the inability to withdraw your capital whenever you want.

A few investors with seas with capital, good connections and excellent analytical skills may be able to select winners in private markets. Most others, big and small, should not feel as though they lack a secure way to beat the rich.

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