08.02.2023

Expectations bubble

As investors, we often hear the phrase buy expectations, sell facts. This phrase perfectly describes the entire venture capital economic model of the last 15 years. As the Internet has evolved and become pervasive in every sphere of life, penetrating every layer of the population, the criteria for evaluating businesses and projects have changed dramatically. Of course we are still talking about the NPV of projects, assessing revenues, etc. But now there is a huge layer of projects whose key indicators are expectations.

Probably everything can be tied to expectations, of course. Expectations of revenue growth, new markets, cost optimization, and eventually profit. However, here we are talking about a completely different approach to what is happening. 

One prime example is Uber and its IPO. UBER had its IPO in May 2019 at a valuation of $82.4 billion – which was already at the lower end of estimates. And half a year later, in October 2019, the company’s market capitalization dipped below $50 billion. Uber is the same company that has been made possible by the fact that the smartphone has become available to almost anyone, and travelling around the world has become the norm. And accordingly, you didn’t have to now show a driver in an unknown country where and how to turn and expect to be cheated on the price. People lived with expectations. Even those who did not use the service noted that it was a significant breakthrough – the exclusion of complex and capital-intensive taxi companies from the profit system, clear localization, security, transparency and many other good things. 

On all of these expectations in the closed rounds, Uber was growing like a leap. But what about its actual performance as a company – profit? Revenue? EBITDA 2019 was -$8124 million. At the same time, the estimate was 82400. Seems crazy, but the issue wasn’t current earnings, it was expectations. It was also the issue of cheap money. With the Fed rate near 0, the cost of borrowing was also tending toward zero and the money was almost free for institutional investors. The goal was to convince the next investor that expectations would come true and get out quickly. Seems like something reminiscent of that….

Another interesting case is the purchase of WhatsApp by Facebook back then. WhatsApp had a valuation in users – about $18 per user. And this is a very interesting estimate, because at that time, WhatsApp did not monetize them in any way. All the users were using the service for free, we had a lot of users and they were spending a lot of money on infrastructure maintenance. Why was it $18 for users who did not bring anything? Again, expectations. But maybe the deal was not so bad, because in fact FB bought itself a database of users for 18 bucks, when it was sort of attracting a user for 35. In that way it looks reasonable, but then again – there was no revenue at the time, only expectations.

Now the most interesting player is Tesla. A company that has long lived more in Ilon Musk’s tweets than in the real world. And a little infographic on it.

There are quite a number of car companies in the world, particularly German and Japanese ones. Most of these car companies not only have been on the market for a long time, but they have a stable business model and many markets where they have a presence. Each such company engaged in civil engineering can boast of a structure, both financial and economic, which is more developed and elaborated than the structure of some states.

Tesla, on the other hand, has only a few models, these models, in fact, have not been updated in any way since their release date. Tesla has a concentration of production in the United States. Now Tesla is actively developing Asia, but it is no match to the ramified network of other automakers. Maybe this company is just very profitable. Tesla posted its first marginal profit in Q4 2019. 

The company, whose market capitalization is actually comparable to that of the entire auto industry, has a completely unsightly revenue mix and a weak model lineup. However, investors actively believe in it. Exactly believe – the most suitable term here. In many respects, the company is associated exclusively with Ilon Musk and his tweets. There was already a precedent when the U.S. Securities and Exchange Commission (SEC) investigated Musk after he tweeted that he was ready to take the company private. This provoked strong fluctuations in the market and drew the attention of regulators. After these experiments Musk is spoiling mostly with cryptocurrency – the fluctuations of these assets are not so worried about the regulator in the U.S. and accordingly can not gather a big wave of outrage and a class action lawsuit.

However, as for the expectations and vision of the founder. The company deserves respect simply because Elon Musk was able, through social media and his image, to sell something that he had not yet had time to produce and work out. Tesla was primarily an expectation, not a finished product. An expectation for ordinary users. It is unlikely that those who appreciate the driving quality of German cars will be able to truly appreciate an American manufacturer. Anyway, the quality of materials there as well as in any good American-made car is at the level of the third world countries and the most of elements are made according to the principle – cheap and hearty. 

Anyway, consumers of Tesla are not especially worrying about it. They are more worried about something else – they do not need to change oil in the gearbox, choose the interior trim, think about what equipment to put as an extra option. They care that the car has a modern look, does not cause any problems, charges together with their smartphone and very soon will drive itself according to the coordinates entered in the onboard computer. Right now, though, the autopilot is extremely limited, even though Elon Musk is trying in every way to show that it is perfect. But again, these are the expectations that the market is buying today.

What will happen next, after the inflation rate in developed countries has actually risen to 10% in 2022, and production has started to stagnate. The price of components and materials has gone up, logistics have multiplied in cost, and the charge of borrowing has become unprecedentedly high?

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