A popular darling startup is worth $1 Trillion

This is not against any startups or businesses that are focused on serving the unmet needs of customers with a product that is far superior to alternatives. This is on those armchair analysts and social media cheerleaders who make up things to tell us that those startups are larger than they really are.  The business leaders of these ventures will correctly point out where they stand in reality with respect to blogger or market expectations. See for example Elon Musk (CEO of Tesla),

“The stock price that we have is more than we have any right to deserve,”

For those not actually running the business – breaking new market, building new channels, acquiring customers, investing in  R&D and market development etc. – it is just making up things to grab page views. One such article is on valuation of Uber. It is titled, Uber is going to be the next $100 billion company.

I do not know, it very well could be. But as I have said before, if the methods by which the answer was arrived is wrong we should reject the answer. Let me point out the flaws in the argument for even justifying $10 billion valuation let alone $100 billion.

Input: The article cites sources that Uber had a gross revenue of $1 billion growing to $3 billion this year. And a EBITDA of $400 million.

Method: Then it assigns a EBITDA multiple of 8-15X, stating just that “it is reasonable”.

Output: Then jumps to a valuation of $6 billion (400 times 15). It does not stop there – oh by the way since the E is growing $6 billion to $10 billion is child’s play.

There is no big problem with input. Other leaked reports have stated Uber gross revenue of $20 million a week. At 20% cut Uber’s real revenue is about $200 million a year.

There is a problem with the method. It uses a multiple that has no basis or fails to tell us what the basis is. Using EBITDA multiples to value companies is a fair method except that the multiple applied has to be rooted in some logic. The multiple should be based on

  1. Current market size and market growth
  2. Current firm revenue and past growth
  3. Future growth rate
  4. Market dynamics, shifts, trends, competition
  5. Firm’s ability to consistently execute to capture the said growth given market dynamics

To assign a multiple of 15X based only on past growth (when the product is in its exponential part of growth curve) is at best overly optimistic  and at worst downright wrong.

Even if we accept that the mistake is trivial the silliest of all mistakes is how it jumps from $6 billion to $10 billion. It once again applies the high growth rate of EBITDA to bump up to 10. That is it not only applied the high growth rate to assign 15X, the high end of its 8X-15X estimate, it does it again to get to a number it wants. That is like a EBITDA multiple of 25X.

Since the method by which the article arrived at the answer is wrong we must reject the answer.

Let us not even go to how it jumps from $10 billion to $100 billion. It bases that argument on potential on how the platform could be used to do lot more things than just hailing cabs. What about the uncertainties?

So how would you do this valuation right? You surely won’t attempt that in a blog post. But here is a method with more rigor.

  1. Current taxi market size in US is $11 billion
  2. Past growth rate has been 3.5%
  3. Likely future growth is close, but let us say it is 3.5% to 7% (90% confidence estimate)
  4.  Let us say the total world market size (including US) is $15 to $22 billion (90% confident estimate)
  5. Uber’s current share of US market is about 10% ($1 billion in $11 billion)
  6. With its growth let us say the future share is 20% to 60% (again 90% confident estimate)
  7. Then you find out what is the most likely scenario in next five years.
  8. Finally apply a multiple based on comparable businesses, noting that the market size is capped, and give a range for the valuation

If you want to model the most optimistic number – say Uber captures 100% of world market on taxi cab in 5 years. Let us say the market grows at 5% from its current $22 billion and they still make 20% of fare as their real revenue. That comes to Uber revenue in 5 years to be $5.6 billion. And that is it with no where to go in Taxi revenue. Would that justify $10 billion valuation. Sure if indeed all the optimistic conditions I laid out are true.
But you do not just look at most optimistic outcomes regardless of their likelihoods to make valuation prediction but look at all possible outcomes and their likelihoods to make an estimate under uncertainties.

What is your take?

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