The recent spate of scare stories about declining prices in the tech sector are not only wrong — they are irrelevant.
If you’re a corporate investor looking to acquire a startup, this latest round of media noise, gossip, and chitchat is distracting.
Rather than obsessing over the market and whether there’s a newly pumped-up bubble or not, you may well be a lot better off taking a step back; giving yourself the chance to ask not whether the price of Snap, Cloudera, or Alfa Financial Software is sensible, but whether — as an investor — it’s sensible for you.
If you look at five poorly performing tech stocks, their declining values probably have much more to do with their individual business strategies than market conditions generally
That is because prices don’t exist in isolation. Prices are indication of what the market is prepared to pay for shares in a business at any one particular point in time. More importantly yet, prices signal the value an acquirer feels it can extract from an acquisition target. So, rather than trying to look outside of your company to find the value of a startup target, look inside first.
Tech is a fast-moving world, and so are the stories
This latest round of hysteria started with an article in Bloomberg about a string of startups who are, potentially, floating on the stock market at a price below their pre-IPO valuations. Cloudera was cited as the first tech unicorn to go public at a value “significantly” below its private valuation. HortonWorks and Apptio were also referenced.
But, what’s the real news here? Companies fluctuate in price — and value — all the time. Some go up, some go down. That is usually because a company’s individual strategy has succeeded or failed, its revenues are growing or shrinking against expectations, or its outlook is positive or negative.
For every company you can find whose valuation declined after going public, you can probably find another one that rose
It’s very difficult, if not impossible, to extricate the individual circumstances of company valuations, and draw much bigger, wider conclusions — especially about an industry as diverse and broad as the technology sector. If you look at five poorly performing tech stocks, their declining values probably have much more to do with their individual business strategies than market conditions generally.
For every company you can find whose valuation declined after going public, you can probably find another one that rose. Facebook is a case in point. Since its float in 2012 at a peak market capitalisation of about $100bn, it has increased in value more than fourfold. Currently its market capitalisation is over $430 billion. At the time it floated, you could find a lot of scare stories about the tech bubble and how Facebook was yet another example of an overvalued tech company that would eventually collapse.
The same reaction took place when it announced it was acquiring Instagram for $1 billion. How very wrong they were.
It’s natural to see price jumps when going from private to public
You also hear a lot about private tech companies’ valuations jumping about all over the place.
This volatility, we may think, is a signal that something is not quite right in the market. So, perhaps, it’s not that Cloudera’s price has declined, but that it has declined by so much so quickly. But that’s not clear either. It’s natural to see price jumps when a company is private, or goes from private to public. This is not volatility. It’s not even really correct to call it a “price jump” at all.
These fluctuations in price simply reflect the fact that private companies are typically valued only at landmark events, such as capital raises, acquisitions, or IPOs. And a very long time — usually years — can pass between these landmark events, meaning most of the time the true value of the company is hidden; whereas public companies are valued day-in, day-out on the public markets, meaning that price declines usually follow smooth downward curves. That is usually enough to explain what seems, on the surface, to be a rapid, immediate change in value.
The risk of scare stories, and why they truly matter
The risk of all this media noise around the price of tech startups is that it distracts strategic investors from making the right decision. You can see this happening in two ways. On one hand, the CFO of a major corporate might be scared off by the stories from acquiring a startup, thinking that a market correction is imminent and they could end up destroying value. On the other hand, they may sweep into the market, acquiring a startup at what they think is a bargain price without doing enough due diligence.
When a corporate is looking to invest or acquire a startup, they shouldn’t be thinking primarily about the wider market but, instead, about what value the target company will provide to them
These are both wrong. When a corporate is looking to invest or acquire a startup, they shouldn’t be thinking primarily about the wider market but, instead, about what value the target company will provide to them: the synergies the investment or acquisition will create, and how the target can help the corporate transform itself to keep pace with digital change. This is why a target company, which may seem small or insignificant, can actually command a large valuation, and price, to the right company.
For example, in 2005, Google spent $50 million on a tiny company, which very few people knew about at the time and which was developing software for mobile phones well before such a thing was fashionable. It had only been in existence for 22 months. Many commentators couldn’t understand the acquisition, and accused Google of making a strategic error. What was the company? Android. It has since gone on to become the leading mobile phone operating system in the world, used on more than 1.6 billion devices around the world.
While the price might have seemed high at the time, it wasn’t. Google had a vision to bring its services to mobile — as consumers increasingly adopted handheld devices — and Android was a key rung in its strategy. Would Android have been worth $50 million to another company? Perhaps not, but it was worth it to Google because it was a great strategic fit, and enabled Google to unleash enormous latent value.
Almost any price can be the right price
The lesson from this is that almost any price can be the right price from the right company for the right asset.
Corporate investors, who are increasingly struggling to keep pace with the latest technological developments, need to look inside their own companies, develop a strategy to transform themselves for the future and then — and only then — go out to the market to find a good strategic fit, ignoring in the first instance prices, and even in some cases numbers. Prices can distract from finding the right company, which is what truly matters.
The lesson from this is that almost any price can be the right price from the right company for the right asset
After this company has been uncovered, then a corporate can start asking the difficult questions about value: what historic value information do we have? Can we benchmark the company against other similar competitors? And, most importantly of all, what strategic value will the acquisition unleash in my company that it wouldn’t be possible to uncap otherwise?
Corporates need to find a startup that fits their company like a glove, and agree to a price and terms that make sense with all the other value elements taken into account. If corporates can do that, they will have the best chance of finding a transformative acquisition target that works for them. Then they have to execute, which is a topic for another article…
Paul Cuatrecasas is CEO and Founder of Aquaa Partners, a London-based investment bank that works with growth-focused corporates to help them find and acquire the right technology company.
Find out more about how Aquaa Partners can help you at: http://aquaapartners.com
Hacker Noon is how hackers start their afternoons. We’re a part of the @AMI family. We are now accepting submissions and happy to discuss advertising & sponsorship opportunities.
If you enjoyed this story, we recommend reading our latest tech stories and trending tech stories. Until next time, don’t take the realities of the world for granted!