The rise of the unicorns

Ten of the most interesting and disruptive companies you can’t invest in (yet).

Summary: Right now a number of important and disruptive companies are being funded at the stage before they float on the share market. While we can’t invest in their shares right now, they deserve our attention as potential future investments as well as powerful competitors of companies we already own.

Key take-out: Don’t enter into the unicorns’ initial public offerings. Rather, let them become seasoned and decline to attractive levels after the hype – as they often do – and buy then.

Key beneficiaries: International investors Category: International shares.

The pace of technological change is accelerating. So too is the time frame where an idea morphs into a fully funded start up that becomes a public company. Think Facebook, Twitter, Linkedin, and Tesla.

Right now there are a number of important, disruptive companies currently being funded at the pre-initial public offering (IPO) stage. Even though we can’t invest in their shares right now, many of these companies deserve our attention not only as potential future investments but also as powerful competitors of companies that we may already own.

The companies are called “unicorns” after the mythical beast. They are start- ups that already have an implied valuation in excess of $US1 billion. They used to be a rarity, hence the term. By last count there were more than 80 of them, the largest amount ever.

Some of the more compelling are Uber, Airbnb, Snapchat, Palantir, SpaceX, Pinterest, Dropbox, Square, Cloudera and Stripe, which we have listed below in descending order by market capitalisation.                                                                                     

1. Uber

Uber’s app connects drivers to riders in 55 countries, with pricing that varies with demand. Founded in 2009 by current chief executive Travis Kalanick, Uber is disrupting established taxi fleets and other transport industries as it aggressively expands into new global markets.

It is the most valuable of the unicorns with an estimated valuation of $US50 bn. Only Facebook has sported a similar pre-IPO valuation. Uber has managed to grow in spite of strong opposition from municipal officials, the taxi industry, and even entire governments. That’s the price of disruption.

2. Airbnb

Airbnb is basically a website that allows users to book apartments, homes and other temporary accommodations. Founded in 2008 by current chief executive Brian Chesky and headquartered in San Francisco, it currently has over 1m listings in some 198 countries. Currently the company sports a private market valuation of $US20bn.

Who is it disrupting? The established hotel/lodging industry and also municipal councils who have overly regulated property owners for decades.

Like Uber, the company has grown in spite of attacks from local and state governments who are losing out on the substantial taxes generated from the hotel industry and bemoan the inability to regulate the sharing economy.

Airbnb’s next leg of growth may come from business travellers, who are just 10 per cent of customers at this point. Also, smaller hotels are starting to use Airbnb’s room listings.

3. Snapchat

Snapchat’s messaging app lets users take and share images and videos that disappear once they are viewed.

Founded in 2011 by three Stanford undergrads, the pictures and videos are sent to a controlled list of recipients with a time limit (set up by the sender) for viewing. The latest range is between 1 and 10 seconds after which they are deleted from Snapchat’s servers. Larger video and photo montages can be active for up to 24 hours. Snapchat has an implied valuation of $US15bn.

There are also numerous messaging applications and a cash transfer feature was added in late 2014 (Snapcash). In a recent survey, Snapchat was ranked the third most popular social app after Facebook and Instagram among millennials. Not surprisingly the company has apparently knocked back offers from Facebook and Google to acquire the company.

4. Palantir

Palantir Technologies specialises in data analysis for cybersecurity applications and has a current valuation of over $US15bn.

Serial entrepreneur Peter Thiel (a co-founder of PayPal) founded the company with four colleagues in 2004.  It serves three main industries: government, financial services and law enforcement. One of its original backers was the CIA and today Palantir counts most investigative arms of the US government (FBI, NHS, CDC) as clients, as well as many financial services firms (JP Morgan) and of course the military.

The company’s proprietary products involve sophisticated analysis of large data sets in order to uncover security threats, fraudulent online activities, facilitate disaster response, provide powerful forensic analysis for law enforcement and even track disease outbreaks.

5. SpaceX

Space Exploration Technologies Corporation is a designer and builder of spacecraft for commercial and military applications and sports a value of $US13bn.

The company was established in 2002 by Elon Musk, chief executive and founder of Tesla. The company aims to significantly reduce the costs involved in satellite launches and supporting orbiting space stations with a view to eventually colonising Mars!

SpaceX is the only private company to have docked on the International Space Station. In January 2015 the company also announced they would be a major satellite manufacturer and would also launch a global internet network comprised of an array of some 4,000 satellites.

6. Pinterest

Valued at $US11bn, the company’s online bookmarking tool allows people to save collections of images and digital content and share them in the form of “pins” or “pinboards”. Businesses also use Pinterest to serve as a “virtual storefront”. Fashion retailers use it for style trending and access to its predominately female (over 85 per cent) user base.

Pinterest was founded in March 2010 by Ben Silbermann, an ex-Google customer support employee. In 2014, Pinterest started generating revenue by charging advertisers who are targeting Pinterest’s 70m users worldwide. US users are estimated at 47m. Given the size and sophistication of Pinterest’s user base and boutique like ambience (if there is such a thing online), some marketers have branded the company as “the internet’s latest great revenue-generating hope”.

7. Dropbox

Dropbox is a service that lets users upload and share photos, documents and videos with specific people. Essentially it is a sophisticated file hosting service that allows cloud storage and folders that can be synchronised and accessed by any computing device. Dropbox service is free to a certain level of storage.

The company was founded by two M.I.T. students in 2007 with seed funding from Y Combinator and sports a valuation of some $US10bn.

Industry reviews have been very positive calling it “the best cloud backup services for facilitating long-term online data backup.”  Even the lowest level of paid service “Dropbox Pro” offers 1 terabyte of storage for $US10.99/month. For businesses, storage is unlimited for $US17/month.

8. Square

Square is an electronic payments company that is branching out into financial services and analytics. Currently valued at $US6bn, the company was started in 2010 by Jack Dorsey (the current chief executive and a Twitter co-founder) when a friend was unable to complete a transaction because his business wasn’t set up to accept credit cards. Dorsey developed a reader that could be linked to a mobile phone to accept payments: the Square Reader.

Since then the company has branched out into point of sale software for iPhones, iPods, iPads and Android mobile phones. Square makes money by taking a percentage from each transaction. In 2014, it processed about $US30bn of transactions. Square is also attempting to monetise the point of sale data.

9. Cloudera

Cloudera is a data management software firm aimed at helping companies store, process and analyse large data sets. Currently valued at $US4bn, Cloudera is another big data player (like Splunk) with a difference in that it offers its software as open source.

The company was founded in 2009 by three ex-Google, Yahoo and Facebook engineers as well as ex-Oracle executive Mike Olsen, who is currently chairman.

Its Apache Hadoop products are targeted at the large enterprise and offer unlimited scalability in order to process vast amounts of data.

10. Stripe

Stripe is an online payments processor for individuals, small businesses and app developers. Founded in 2010 by Patrick and John Collison, it has secured funding from the usual Silicon Valley venture capitalists such as Sequoia Capital and Andreessen Horowitz, but also from also Peter Thiel (PayPal, Palantir)  and Elon Musk (Tesla, SpaceX).

Stripe is a direct competitor to PayPal and seeks to simplify the money transfer process. Stripe is working with some of the largest tech players like Facebook and Twitter as well as start-ups Lyft and Instacart. Stripe is currently valued at $US3.5bn.

But are the unicorns overvalued?

So who is providing the funding for these disruptive, high growth, but (usually) unprofitable companies? Traditionally it has been the venture capital (VC) concerns that back early stage companies and then profit when their charges go public. There are over 800 VC firms in the US.

There are also more and more non-traditional investors participating  such as pension funds, mutual funds such as Fidelity and T. Rowe Price as well as hedge funds and of course private equity.

Some commentators have remarked that the relative ease of financing is creating a private market bubble that could be unsustainable. However private market valuations are somewhat different to public ones due to the more favourable terms that their investors receive. These can be anything from seniority relative to firm assets in case of liquidation, guarantees as to a minimum IPO price and some protection if the IPO price is considerably less than the private market valuation. The increase in the number of participants could also be responsible for elevated valuations and the number of billion dollar start-ups.

One thing is certain, there will be a time when money is harder to come by and financing rounds are few and far between. It will probably be precipitated by a severe stock market correction, significant economic downturn, or a few high profile unicorns that don’t work out.

What I find fascinating, observing companies like these, is they begin with an idea by people who are visionaries, personally driven, and possess a potentially disruptive technology.

Examples from the past include Bill Gates (Microsoft), Steve Jobs (Apple), Elon Musk (Tesla), Jeff Bezos (Amazon), Mark Zuckerberg (Facebook), Larry Page / Sergey Brin (Google), Reed Hastings (Netflix), and of course Peter Thiel (PayPal and Palantir) who suggests budding entrepreneurs ponder “what valuable company is nobody building?” and not what has worked in the past.

What most of the well-funded unicorns have in common is the founder or founders are still running the company and have the credibility to raise serious money from multiple sources. They also have the “luxury” of being private; they don’t have to file quarterly earnings statements or convince buy side security analysts of their investment appeal, and they are able to attract and retain staff with the promise of an IPO windfall when the company goes public.

When to buy the unicorns

Eventually, however, these companies will need additional funds to grow the business and that’s where the capital markets come in. Also, their original backers want to cash out on favourable terms. My sense is that most of these high profile companies will go public over the next 12 months and that’s why they are worth watching.

However, as I’ve said before, I am not a fan of buying IPOs, no matter how attractive or interesting the company is. It is truly a “mug’s game” and individual investors and even most institutions don’t stand a chance given that the price is not determined by what the company is worth but rather by the perceived demand for the shares.

Many of these neophyte disrupters will be overhyped by the financial media and the brokers, with the result that the share price will have a huge run on day one. Some will be up 25-50 per cent on the opening bell. That is not the time to buy them. Do, however, keep an eye on the stock price and read the prospectus.

Then, let them become “seasoned”, pick up some analyst coverage, and report a quarter (or two) as a public company. By waiting, there is always the risk that you might forego some upside, but in my experience many hot IPOs revisit the original offering price (or lower) at a future date.

Facebook and Tesla are good examples of over hyped, over-priced IPOs that declined to attractive levels once public and provided attractive entry points for savvy investors (myself included).