An Entrepreneur’s Wet Dream
I hope you’re here because you have entrepreneurial ambitions like I do. If so, I suspect you’re aware of the news about IPOs this year. More specifically, I’m referring to the eye-popping market caps these companies have been achieving on day one.
The questions that have been going through my mind are, are they justified? Are we experiencing echoes of the irrational exuberance that lead to the dot com meltdown of the early 2000s? Or are we in a new, permanent economy where the $1B market cap is hardly even unicorn status anymore?
As a disclaimer, I’d like to mention I’m not an investment professional. Nothing I say should be construed as investment advice. I do not own any shares of these companies. Do your due diligence people!
First Up, DoorDash
The first example I want to touch on is DoorDash. I don’t think I’m rocking the boat with my opinion that it’s very overvalued. This remains true even with the drawback that has occurred since the IPO.
Obviously, some people thought it was a great investment, that’s why they paid through the nose for the stock. But a lot of the murmurs on social media accounts and forums about stocks and investing are pretty bearish. DoorDash is certainly the biggest player in the arena it competes in. But that seems to be about the only significant advantage they possess that can explain their valuation.
DoorDash doesn’t have any sort of economic moat. That is, it doesn’t have a distinct advantage over its competitors, allowing it to protect its market share and profitability. No special technology, no lucrative government contracts etc.
The space DoorDash competes in is not a particularly innovative one. What they do isn’t really original. It’s just another layer on top of something people have done for quite some time, ordering food. They’ve added some value there, apparently, otherwise it’s likely no one would bother with them. Anecdotally, I can say restaurants are notoriously bad at taking orders. A bit strange really since they should be incentivized to be good at that sort of thing. They leave you on hold forever, the person on the phone is difficult to understand, so on and so forth. But in that regard, DoorDash doesn’t do anything GrubHub, UberEats, or any other competitor does.
Other Problems DoorDash Runs Into
Furthermore, restaurants don’t like these companies, first and foremost because they cut significantly into their margins. This is something a lot of restaurants have struggled with in light of COVID-19. Necessity being the mother of invention, restaurants have been encouraging more people to pick up their food rather than use DoorDash or other third party apps. They’re hoping to avoid commission fees that are often as high as 17%.
Additionally, many cities are sympathetic to the restaurants they are shuttering because of COVID-19. They are enforcing commission caps on DoorDash and their competitors. This constrains revenue, and is a sign of a vulnerability in these companies business models. They’re very susceptible to government regulation and law.
I recently heard that DoorDash will often create a menu for restaurants it does not contract with, and fulfill customers orders regardless. This was whispered anonymously on a Reddit thread, so take it for what you will,
As you can imagine, restaurants this happens to are often resentful for being represented in ways they did not consent to, like having their food prices marked up so DoorDash can make money from the orders they aren’t getting from commissions. These restaurants try to put a stop to this, but are largely powerless to do anything.
One of the Biggest Sticking Points for Justifying DoorDash’s Market Cap is…
DoorDash isn’t profitable. This isn’t, in and of itself, always a problem for a company’s stock price. Stocks are often priced based on expectations of growth of revenues and profits. Many companies eschew profits in the short term in order to reinvest and grow the company rapidly. This was certainly unorthodox once upon a time, but then companies like Amazon and salesforce.com sold investors on such a strategy by convincing them they would more rapidly obtain a greater return on their investment.
The thing is, they need to be able to make those profits eventually. With DoorDash, it isn’t clear their lack of profitability is solely due to rapid expansion.
With the aforementioned pioneers of the rapid expansion model and companies like them, the margins are huge, and they have no problem making profits from a fundamental business activity standpoint as long as their product is selling. This means they can pump the brakes on expansion whenever they want and basically print money.
With DoorDash and its competitors, it’s less clear they can simply switch gears and make the metaphorical printers go “brrr”. They’re not actually tech companies, they don’t have corresponding margins.
Add to the fact the future revenue growth DoorDash is depending upon is by no means promised, and I think you’ve got potential problems for their stock price. In case I haven’t made myself clear, I’m not sure why DoorDash has such a high market cap.
Next, We Have Airbnb
I definitely don’t look at Airbnb the same way I look at DoorDash. Airbnb came and, forgive me for my corporate jargon, “disrupted” the hospitality industry. They have added value in a unique way. People using Airbnb get something hotels can’t really provide them with, a unique experience of their travel destination, the feeling of really being “in the thick of it” wherever they go to. Oftentimes, Airbnbs are cheaper than a hotel with the accommodations they require, and staying in an apartment can feel more comfortable than a stuffy old hotel.
As far as I can tell, they don’t seem to have much in the way of competition, not from anyone with what could be accurately described as a similar value add. They’re still only being challenged by the hotel industry and third party websites that accommodate travelers seeking to stay at hotels, but since Airbnb’s inception, it’s really been them doing the challenging.
That having been said, there are certainly weak spots for Airbnb.
Like DoorDash, they have to be concerned with municipal ordinances. Much more so in fact. It shouldn’t come as a surprise that locals don’t like living near Airbnbs, as transients coming and going means drama, noise, potentially even violence and danger.
Residents in many large cities, and I’m sure in small cities and towns too, have made their displeasure with the Wild West free-for-all of Airbnbs popping up all over their neighborhoods, and local leaders have listened. In LA for instance, many Airbnbs are being rented illegally, though as the article points out, this is often intentionally in defiance of the law. Still, you have to wonder how long they can keep getting away with it. This isn’t jaywalking after all.
Other Problems Airbnb Runs Into
The next point I’ll raise should be fairly obvious. As a hospitality company, Airbnb is of course vulnerable to anything that restricts travel, such as a once in a century global pandemic. According to their prospectus, growth was on a tear, right up until COVID hit, when it basically plummeted by ~$1B overnight in March when lockdowns began. This is a pretty big hole to dig themselves out of, but if predictions of pent up travel demand being unleashed in the post-COVID world pan out to be true, they could recover quite quickly. They’ll just have to hope nothing like this ever happens again.
The last point I’ll make about Airbnb is that, like DoorDash, profitability is a concern. Their growth had been tremendous until they were blindsided like the rest of the world by COVID, but profits have always remained elusive. Unlike DoorDash, who briefly turned a profit, Airbnb has not done so, and according to the article linked to in the last paragraph, has admitted in their prospectus they may never be able to do so. And what good is growth without eventual profit? Though Airbnb’s market cap is a bit more understandable than DoorDash’s, it still seems to be unjustifiably high.
What’s Causing All of This?
You’ll hear all sorts of explanations about where all of this irrationally exuberant money being parked into equities is coming from, and it’s really hard to know exactly where given all of the views being offered.
I certainly don’t believe millenials on Robinhood are responsible for an influx of YOLO money that’s driving up equity prices. When compared to the institutional investors, whose cumulative assets under management each can number in the hundreds of billions and trillions, younger investors on apps are tossing in peanuts by comparison.
Why are institutional investors, with all of their expertise, buying up such questionable investments? The best explanation I can find is that a fragile economy, propped up by an ever expanding money supply and record low interest rates, is rife for this sort of thing.
Investors simply seem to be at a loss for alternatives. Cash loses value due to inflation, and bonds offer little in the way of returns, certainly nothing like they used to. So, anyone looking to grow their money, the reason why institutional investors exist, puts it in equities.
So, is This the Next Dot Com Bubble?
I certainly don’t have the expertise to confidently draw a line in the sand for either a yes or a no. I will reiterate that I think there are echoes of the dot com bubble. Both were markets that were seemingly overheated due to pie in the sky expectations of growth at the companies in question. As a consequence of course, you’d expect similar problems.
When is a company supposed to realize the profits it’s expected to make?
There’s no hard and fast answer. If it were say, ten years from IPO, well then as soon as that achievement seems out of reach, the market cap would naturally decline as investors flee.
But there’s no consensus. So once someone or enough someones get spooked by the prospect of profit expectations not being fulfilled, we could see significant drawback on the assets in question, and it can happen really fast. This is how bubbles burst. It’s really how all share prices lose momentum, but bubbles are more vulnerable. All the way back to Tulip Mania in the Netherlands, once the prices become too much because they’ve grown too high too fast, and buyers/investors don’t see requisite value for the risk they’re taking on, the whole thing can come unraveled. It only takes a single thread to be pulled.
What Are the Differences?
That having been said, this is also different in some ways than the dot com bubble. At least these companies do something, have sales if not profits.
The same could not be said of most of the dot com failures. Many dot com companies had obscene valuations without even revenue to speak of. That alone makes what’s going on right now, the excessive growth in market cap of newly public tech or “tech adjacent” companies, something other than a facsimile of the dot com bubble, despite all the Kool-Aid manufacturing, excessive emphasis on swag and perks, overreliance on jargon, and indulgent partying being hallmarks of both eras. The expectation of future profit for companies like DoorDash and Airbnb is at least somewhat grounded in reality, though very loosely so.
As always, would love for my thoughts to provoke a discussion from fellow entrepreneurs from all stages of the journey. Let me know what you think. I’m going to follow this up with a post on Tesla which is different animal altogether. But, Tesla has a very high market cap that is at least somewhat controversial. If you’re interested in some data I’ve compiled about the largest companies by market cap, specifically their ownership % by institutional investors and their short interest, click the links provided.