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Horses vs. unicorns: Public companies at big disadvantage to hot startups

Michael Santoli
Michael Santoli
The CEO of the online marketplace Etsy, Chad Dickerson (C) stands on the floor of the Nasdaq as the company goes public under the ticker symbol "ETSY" on April 16, 2015 in New York City (AFP Photo/Spencer Platt)

Upon Etsy Inc.’s (ETSY) market debut last week, CEO Chad Dickerson gave celebratory interviews wearing an outfit entirely acquired from “makers” who sell through Etsy's online marketplace as the stock soared 88% from its initial offering price, stretching its market value to nearly $4 billion and delivering him a $70 million personal payday.

The poor guy.

That’s not a comment on the e-commerce company’s growth prospects or valuation (both of which present challenges of their own for Dickerson).

Rather, this expression of sympathy is a nod toward the burden of being a public company CEO in a fast-changing business that’s full of heat-seeking venture capital bankrolling private glamour companies.

Many wolf whistles and eye rolls have been directed at the swelling valuations of marquee private young "unicorns," or private companies worth $1 billion or more: Uber valued by venture capital firms at $40 billion, Airbnb at $20 billion, Snapchat at $15 billion, Spotify at more than $8 billion.

Yet less noticed is how tough it is for already-public companies that operate adjacent to these private juggernauts to compete for attention and market share. They need to struggle to produce bottom-line results for demanding investors today, rather than a glorious payoff in some bountiful, idealized future. It's tough to be a workhorse when being judged against unicorns.

The vivid contrast between private haves and public have-nots is nicely illustrated by the graphic below. The shares of home-rental marketplace HomeAway Inc. (AWAY) and music-streaming service Pandora Inc. (P) have gone roughly sideways since their IPOs in 2011, leaving each with a market value between $3 billion and $4 billion.

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Meantime, similar businesses Airbnb and Spotify have ramped from below $500 million six years ago to private valuations that dwarf HomeAway and Pandora, respectively.

 

Those private giants got so big, so fast, because Silicon Valley investors anointed them as the likely leaders in fast-emerging industries. And so they were given more cash, at higher valuations, to spend more quickly to grow as fast as possible, without trying to turn an immediate profit. It's not just that investors aren't using the public stocks as a "proxy" for the private darlings. It's that a public company isn't permitted to execute the kind of breakneck investments and rapid strategy switchbacks that drive the fat private valuations.

HomeAway CEO Brian Sharples, whose core focus is on full-home vacation rentals, likes to say it’s not quite going head-to-head with Airbnb, which began with spare-room rentals in urban primary residences. Pandora executives, too, bristle at direct comparisons with Spotify:  Pandora says it’s aiming at ad-supported radio, while insisting that Spotify offers “on demand” music streams.

Yet the very fact that these folks are constantly being asked about how they stack up to those private players is a hassle for CEOs and a distraction for their investors. It’s hard to look great when being compared to private companies that hog all the buzz without having to report detailed finances.

Dickerson at Etsy might learn this soon, when analysts start asking him about how he stacks up against Pinterest – whose latest valuation is $11 billion – even though Etsy's business model is dramatically different.

Even long-established companies can feel the pinch of venture-backed upstarts who are evaluated using more generous standards. Venture-financed automated investment advisors such as Betterment and Wealthfront have grown rapidly by offering smart, low-fee, no-touch investment portfolios.

When Charles Schwab Corp. (SCHW), with $2.5 trillion in client assets, delivered its answer to these “robo-advisors,” it matched them in most ways - even underpricing them by charging no outright fees.

Yet Schwab was immediately criticized - not least by Wealthfront CEO Adam Nash - for placing client cash in Schwab Bank accounts that earn revenue for the firm. Schwab’s need to earn a decent return on a new business that could draw from its existing ones meant that it couldn’t underprice the service in a way the private firms can.

The cash burn game

Granted, all those private investors could prove wrong and might be overvaluing the hot young startups.  There are plenty of quibbles with just how “real” those private valuations are in the first place. Or maybe the surging private outfits happen to be much better businesses than their public counterparts, with greater scale and a larger market within reach.

Whatever the case, for now, venture companies with buzzy technology or the potential for rapid growth are having lots of relatively undemanding capital lavished on them and are being urged to deploy it quickly in hiring, marketing and acquisitions.

Stewart Butterfield, CEO of workplace-messaging app Slack - which has been given a $2 billion valuation – told New York Times tech columnist Farhad Manjoo: “This is the best time to raise money ever. It might be the best time for any kind of business in any industry to raise money for all of history, like since the time of the ancient Egyptians. It’s certainly the best time for late-stage start-ups to raise money from venture capitalists since this dynamic has been around.”

(The whole interview is worth a read to get a sense of the hot startup economy of today.)

This instructive post by venture capitalist and Yahoo Finance contributor Glenn Solomon advises entrepreneurs on how and when to raise and burn through lots of cash. Reason number one to gun the cash burn rate is to “overwhelm your competition” – which can include public companies with less freedom to sprint for market share with little regard for profit margins.

Compare that game with the way professional investors and analysts scrutinize where each dollar of shareholder cash is directed.

On Pandora’s last quarterly conference call, Bank of America Merrill Lynch analyst Nat Schindler asked CEO Brian McAndrews: “I just want to try to understand your spend and how you're working in your investments for next year…. It’s hard to see where you could really throw that kind of money if you’re really going to grow revenue to $1.16 billion. Are you looking to do substantial, consumer-based advertising to drive usage and if so, if you did that, how would you drive the gross profit, because that doesn’t necessarily sell but drives content price?”

It used to be that the first companies in an industry to go public had the advantage. They could raise more capital quickly, use stock for acquisitions, offer employees equity awards and liquidity and gain “mind share” more easily than obscure private rivals.

But in the current environment, such advantages are diminished or neutralized, as this litany of woes for public companies laid out by top venture capitalist Marc Andreessen highlights.

As a result, an enormous volume of paper wealth is building up outside the public markets. Will a wave of super-sized IPOs eventually hit the market, releasing pent-up pressures to get liquid? This could result in a handful of Facebook Inc. (FB)-style offerings: Already mature “category killers” bursting on the scene to swallow up latecoming public capital at high prices all at once.

Will those already-public companies be rolled up in an acquisition wave as their segments get sorted into winners and losers? Arguably, the valuations of HomeAway and Pandora, for two, incorporate some potential for such a phase.

One way or the other, the investment bankers should stay busy swapping and interbreeding these horses and unicorns.