Should private cos. with large valuations have to disclose metrics?
May 12, 2015
This article is written by Josh Burwick, managing partner at Sand Hill East Ventures. You can check out his blog here.
Did you catch the latest mega financing round for one of the social media darlings?
– Their last quarter revenue grew 80% year over year
– EBITDA surged 182% year over year generating an impressive 24% EBITDA margin
– Their MAU’s (monthly active users) eclipsed 300 million
– And they are on pace to generate over half a billion dollars in EBITDA this year
Nine months ago the company raised a round at a $30 billion valuation. So what do you think the correct valuation is for this current mega round—$40 billion, $50 billion, or $75 billion?
Before you answer, remember Uber raised a similar mega “private IPO” round at $41 billion late in 2014, Airbnb at $20 billion in early 2015, and Snapchat $15-20 billion depending upon different reports. All are smaller in scale and not profitable.
Unfortunately the company is not private but public and subject to the highly critical eyes of analysts and investors who tear apart the financials and disclosures. The company is Twitter (NYSE: TWTR) and the answer to the valuation question is $25 billion and falling (based on recent stock price).
Would this have happened if Twitter were still private? My opinion is no. If Twitter were private they would probably not get a big valuation bump but the round would be up.
Disclosure is the Key
When you are public, the disclosure required of companies increases exponentially. They need to detail their business composition and trends on a quarterly basis in order to stay in compliance with the SEC and stay in the good graces of analysts/investors. Most importantly, public companies are obligated to issue guidance, usually in the form of quarterly and annual targets. If the companies miss these targets they are severely punished.
As I write this blog, LinkedIn reported their first quarter. Revenue beat analysts’ expectations but the guidance for the year was off target resulting in a 25% stock correction! Private companies are immune from these corrections because they are not obligated to issue guidance to investors.
Furthermore, private companies aren’t subject to the in-depth analysis of analysts and hedge funds who keep companies honest through shorting their shares. Private companies have the luxury of planning for the long term while not being penalized for short term variations in their business.
Public companies have to file quarterly 10-Q reports and host earnings calls where analysts/investors ask them questions about any and all things related to their business. The toughest part of being public is making prognostications for where the business will be next quarter and next year. If you predict growth of 30% year over year and it comes in up 28%, it still is good but it will be viewed as a disappointment. It’s all about the expectation game.
For public companies, they need to disclose metrics every quarter which allows analysts to notice deceleration even if it is just a blip. Private companies disclose far fewer metrics and are not obligated to disclose them on a regular basis.
For Twitter in particular, their constant currency revenue growth of 80% y/y was impressive but in the public markets it’s all about the expectations set by company guidance. For Twitter, analysts’ consensus expectation called for roughly 90% y/y so it was viewed as a miss and a big disappointment.
If Twitter were private, they would not have had to issue quarterly guidance so an 80% growth quarter would have looked like continued strength, masking the deceleration and the miss vs. expectations.
How to Remedy
According to a recent quote in The Wall Street Journal, Ben Horowitz of Andreessen Horowitz said:
The late-stage market is “completely unregulated… Companies are required to make
much more limited disclosures about their business than they would during the
process of going public. I think that’s scary”.
The lack of short-term metrics focus allows late stage private companies to have a much longer time horizon. While the long-term horizon is appropriate for earlier stage private companies where business is not mature, later stage private companies should be held to a higher standard of disclosure.
I believe private companies over a certain valuation, say $1 billion should be required to report general quarterly figures such as revenue, margins, cash flow, etc… Unfortunately, these “unicorns” are reaping all the upsides of being treated like a public company with an inflated valuation but without any responsibility of financial disclosures.
Public companies are being held to a higher standard than their private company peers, which has always been the case, but now that valuations are comparable it no longer makes sense. It’s as if the private companies have “tested out” of the due diligence of their peers and are being held to an honor system to divulge metrics as they see fit.
If investors don’t aggressively push for in depth disclosure from private companies, then they are at risk of investing at artificially high valuations. The bare minimum of quarterly reporting would go a long way to instilling some structure and accountability to these private IPO companies.