Mark Palko writes of the Ponzi threshold: “sometimes overhyped companies that start out with viable business plans see their valuation become so inflated that, in order to meet and sustain investor expectations, they have to come up with new and increasingly fantastic longshot schemes, anything that sounds like it might possibly pay off with lottery ticket odds.”
Interesting convergence of ideas, as this reminds me a lot of the (Lance) Armstrong Principle: If you push people to promise more than they can deliver, they’re motivated to cheat.
Here’s Palko’s example (see also here):
First, hype and next-big-thingism push Uber’s value far beyond any defensible level, then, as reality sets in and investors realize that the original business model, though sound, can never possibly justify the money that’s been put into the company, Uber’s management responds with a series of more and more improbable proposals in order to keep the buzz going.
What can be hard to understand with Uber, as with Armstrong, is how things went on like this for so long. It’s practically conventional wisdom now that Uber is trapped, and it was no secret within the cycling world that Lance was doping. But in both cases lots of influential people stayed on the train for a really long time. Part of it must be the sunk cost fallacy or its intellectual/reputational equivalent, part must be the stock pumping idea (if you have money invested in Uber or reputation invested in Lance, then you’d rather keep the bubble afloat for as long as possible), and part of it must be the calculation that it will all work out (in Uber’s case, that might be public subsidies such as juicy citywide Uber contracts for public transit; for Armstrong perhaps the hope was that his anti-doping adversaries would eventually give up).
In any case, whatever one thinks about these particular cases, it’s interesting to see the connection between the Ponzi threshold and the Armstrong principle.
> It’s practically conventional wisdom now that Uber is trapped
Huh? The “conventional wisdom” — which most financial professionals would classify as “current valuation” — is that Uber is worth billions of dollars, perhaps a number like $20 billion. This is down a lot from its valuation a year or two ago, but still hardly “trapped.”
You (and others) may think that Uber is in real trouble, has no viable path to profitability, is doomed to lose to Wyaymo, whatever. But the market definitely disagrees.
Everyone knew the dot com bubble would burst long before it actually did. There are second order reasons why valuations stay high, such as everyone thinking that a bigger sucker will come along and they can get out before the pop…
Behavioral finance is an incredibly deep subject (it’s also fraught with garden of the forking paths in the research) and what Daniel writes is only one of many mechanisms by which market prices are said to deviate from so-called fundamental value. But to stay on topic with what Daniel wrote, here are a few items that may be of interest:
https://en.wikipedia.org/wiki/Greater_fool_theory
and
“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities—that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future—will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”
http://www.berkshirehathaway.com/letters/2000.html
Check out the description of the party clocks with no hands in “the Money Game”
Also googling reveals articles a month or so ago valuing Uber at 60+ billion so if it dropped to 20 in the last few weeks, that’s already proof that Palko was right ;-)
https://www.google.com/amp/s/www.cnbc.com/amp/2018/05/23/uber-q1-financial-data-increased-sales-valuation-with-new-tender-offer.html
Daniel, you may need to be careful here. UBER’s books are closed (it’s a privately held company) and changes in equity valuation may not necessarily reflect changes in Enterprise Value (https://en.wikipedia.org/wiki/Enterprise_value). It’s entirely possible that the equity valuation has changed but the EV has stayed the same; with each equity valuation simply reflecting changes in capitalization structure. May not be the case here (I’d doubt if it was), but thought I’d point it out since it’s important when valuing companies.
Also maybe of interest: http://aswathdamodaran.blogspot.com/2017/06/usersubscriber-economics-alternative.html
Yes, the point is not that Uber is trapped because they are a worthless company. They would be trapped because a significant decrease in valuation makes raising money nearly impossible and a company in this sector requires financing in order to be competitive. Even if a business is completely viable and valuable, a messed up financial structure can tank it, just ask Toy’s R Us (RIP).
D,
The question here is not profitability but of SUFFICIENT profitability to justify peak valuation. The same applies to Netflix and Tesla. The very fact that “[Uber] is down a lot from its valuation a year or two ago”
Trying to justify unjustifiable valuations leads to things like this
https://www.theverge.com/2017/11/8/16613228/uber-flying-car-la-nasa-space-act
It’s a one-sided market; there’s no way for investors to bet against Uber. So the price isn’t set by a market; it’s set by believers.
“If you push people to promise more than they can deliver, they’re motivated to cheat.”
This is always easier said than done. How much push is too much? When you advise a student, do you know his limit? Or when a trainer at the gym takes on a client, does he know the client’s limit? In my opinion, you can and should push, but as to the cut off point, you may never know.
So, productivity and discipline/ethics go hand in hand. I think let go of one hand while holding tight the other is where the problem is. Just my opinion.
On a related Note:
“Tesla Sales: $12 billion General Motors Sales: $144 billion Tesla Market Cap: $58 billion General Motors Market Cap: $55 billion”
https://twitter.com/charliebilello/status/1013853310967844864
See also Netflix and Disney
Comparing Market Cap to Sales between companies with vastly different capital structures is a highly ineffective way to accomplish anything. Enterprise Value helps compare between capital structures, but even still, you need to be extremely careful to consider if the companies you are comparing are in competitive industries that make strictly zero economic profit or are companies that enjoy incumbent competitive advantages.
See, for example, any of Bruce Greenwald’s lectures (some available on YouTube).
Hey, how come nobody mentioned Theranos? Or maybe that deserves a separate post.
The idea of the Ponzi threshold is that they start with a viable business plan. Not sure that applies to Theranos — more straight-up Ponzi — but we did hit it elsewhere.
https://observationalepidemiology.blogspot.com/2018/06/muskification.html
Here’s an interestingly extreme example: The new business model is to give away the money to strangers! “Cash-flush Business-light” indeed.
https://www.nytimes.com/2018/07/01/technology/cryptocurrency-ripple.html
Is the Times now taking cues from this blog? And why not?
For the world of crypto-currencies, the ripple plan borders on rational. They are sitting on billions of dollars worth of a virtual security that will be worth virtually nothing when the bubble pops. Giving away a few hundred million of that security to keep the illusion going might not be a bad idea. I only hope that the recipients of the charitable foundation part of the plan are unloading the XRP ASAP.