3rd Quarter Commentary

“The markets appear to be emerging from a psychotic break from reality. The ugly process of repricing risk has begun. The market's reaction to Uber and Lyft was the Monday morning sunrise ending a young Robert Downey Jr. Miami weekend binge. The shelving of the We and Endeavor IPOs was the market preemptively taking keys away, arresting the bender before it starts.”

Scott Galloway – Professor of Marketing, NYU Stern School of Business

Listen... do you hear that? A bubble is popping. No, we aren’t talking about the stock market... well, at least not the stock market you’re probably thinking about1. Generally, public companies have the economics to back up their lofty valuations, even if those valuations are, well, lofty.2 It is the market for private companies, specifically those backed by venture capital (VC), that looks truly bubblelicious.

Recent years have seen the rise of the well-documented phenomenon of “unicorns” – private companies valued at over one billion dollars, often coming from Silicon Valley. To borrow the terminology of financial commentator Matt Levine, these “unicorns” have grown up and now that they are emerging from the “enchanted forest” of private markets via an IPO, they are discovering that the real world can be a dark and scary place. To name a few examples, Uber, Lyft, Peloton and SmileDirectClub are down 20, 40, 15, and 30 percent respectively since their IPOs this year. If these declines were the cracks in the walls3, then perhaps the failed IPO of WeWork was the VC dam finally breaking.

But first, how did we get here? Consider Steve Jobs. Steve Jobs was a phenomenon. He revolutionized companies and industries – multiple times. His vision was so strong, his presence so over-powering, that he created what some people called a “reality distortion field” where the impossible became possible, and he was able to get his comrades to follow an impossible dream and turn it into a reality. After he built Apple into a global powerhouse (for the second time), he passed away and a slew of books were written about him that lionized his achievements, but also revealed that he was kind of a jerk. Naturally, people wanted to emulate his successes. Millions of people read these books, saw these things, and learned the wrong lesson. The lesson some learned was: to be a visionary leader, you have to be a jerk. That may have worked for Steve Jobs, but it is not good advice for the average leader. The average person does not have a reality distortion field and instead needs to charm others to get cooperation. The average person is better off, will accomplish more, will be a better leader, by not being a jerk.

The same sort of thing happened with Amazon: people learned the wrong lesson. For years, Amazon grew extremely fast but earned no, or negative, profits along the way. Many people doubted this business strategy would ever be successful. But when Amazon ended up being incredibly valuable, and eventually, profitable, this perception began to change (even though this result was achieved in large part by discovering and succeeding in a different business: cloud computing). The wrong lesson learned was this: it is a great strategy to grow really fast and not care at all about profitability. We disagree: this is not a great strategy for every business, or even most. Most companies are not Amazon. Most companies are not going after the gargantuan market opportunity that Amazon was. It was, and is, clear that online shopping was, and is, going to become more popular; furthermore, the scale is huge, so years of unprofitability could be worth it to get such a prize. But, in another sense, one could argue that Amazon got somewhat lucky with this strategy. It was fortunate to have one of the best CEOs in America. He was willing to try new things, and thus they experimented with Amazon Web Services (AWS) which was a fantastic smash hit. AWS is an amazing business (no ongoing losses there) that currently earns more than half of total company pretax profits.