Uber Plans to Go Public at $120 Billion. How Did the New Tech Bubble Get Here?

This is not Uber's finish line.

Uber, the company that started the sharing economy, is finally going public. Last weekend Uber and Lyft, its main U.S. rival, each filed a prospectus; the listings could come as early as the first quarter of next year.

Uber filed confidentially, to keep its financials away from competitors, so how much it intends to raise is still unknown. Goldman Sachs and Morgan Stanley have already put a $120 billion valuation on it. Uber may not fetch that much on the day, but for years it held the title of the world's most valuable tech startup — until recently, when ByteDance, the parent of Toutiao and Douyin, took it away.

Uber is, of course, a remarkable company. Its run of innovations made hailing a car from a phone real, and changed the business of getting around.

The question is what it is actually worth.

Uber has not earned a cent in eight years. Excluding income from mergers, it lost $4.068 billion over the past year. Whether the number is $72 billion or $120 billion, it looks like a bubble. And the doubts started four years ago.

In 2014, when Uber's valuation reached $17 billion, Aswath Damodaran, a professor at NYU's Stern School of Business, wrote a piece questioning it: the entire taxi market was worth $100 billion, and the money running through Uber came to about 1% of it. Even if Uber grew to 10% of the whole market, it would still take only 20% of each fare — a $17 billion valuation was more than Uber could ever be worth.

Bill Gurley, then an Uber board member and a big-name Silicon Valley investor who had backed the company since 2011, replied with an essay called How to Miss by a Mile. Uber had made getting a ride far easier, he argued, and that would create more demand for travel — people might even give up driving. Uber could also push up and down the value chain and capture more along the way.

Four years on, Uber has indeed grown, and demand for rides is no longer just the taxi market's $100 billion. Goldman Sachs analysts estimate the global ride-hailing market at $36 billion in 2017 and the taxi market at $108 billion. Uber's disclosed financials through June this year show revenue of $9.93 billion over the past year — a third of ride-hailing, and 7.3% of the entire passenger-travel market.

But its valuation has also moved well past $17 billion. At the last round's price, Uber's 75 million monthly riders each carry $960 of market value. Each of them brings Uber $132.4 in revenue — and $101.7 in losses.

That is nearly what an Apple customer carries. Apple, worth $800 billion, has roughly 800 million people using its hardware every month, or $1,000 of market value each. But one Apple user delivers $74.38 in net profit a year.

Uber really has changed how people travel, and it did so by cutting the price of every ride — above all with Uber Pool, the carpooling service it is now pushing worldwide (Didi's carpool feature copied it). The barrier to entry in shared mobility is plainly nothing like Apple's in expensive electronics. Lyft, which announced its own listing for next year at the same time, has competed with Uber in the U.S. the whole way on less money and at smaller scale, and has still kept growing, forcing Uber to keep burning cash.

Uber's global outlook is bleaker than it was in 2014. It pulled out early of the two fastest-growing markets in the world, China and Southeast Asia. In Russia it lost to Yandex, the local "Baidu."

Its most imaginative project, the driverless-car experiment, stopped completely after a pedestrian was killed in September. Before that, Uber was accused of stealing trade secrets from Google's self-driving program and settled only by handing over shares worth about $245 million — and Google's own driverless ride service, now in testing, is a long-term threat.

Up and down the chain of mobility services, Uber has tried car rentals, insurance, food delivery, self-driving trucks, bike-sharing and electric scooters. None of it could hold up the company's results, and the rental business produced a scandal over renting out cars that were under recall. In the end, Uber's revenue is still rides.

Losses that grow in step with growth, new businesses that go nowhere, no monopoly anywhere in the world or at home from which to squeeze profit — that is the reality Uber faces.

Even Bill Gurley, who once defended that valuation, warned in a 2016 essay that startup valuations had gone too high and would create problems later. That June, Uber was worth $68 billion.

Over the past two years Uber took four more rounds, pushing the number to $72 billion. By this October, the IPO pitches from Morgan Stanley and Goldman Sachs carried a $120 billion valuation.

All of it happened while Uber was mired in scandal, with nearly every C-level executive gone and Travis Kalanick, the CEO who helped found the company, fired by his own investors.

$26.9 billion raised in eight years: Uber is the whole tech-startup bubble in miniature

Uber has an official founding story: in 2009 the two founders, Kalanick and Garrett Camp, were out by the Eiffel Tower at night, could not get a cab, and thought how good it would be if you could summon a car from your phone. So they started Uber.

Like most stories founders tell reporters, it is only a story. In fact two serial entrepreneurs mulled the idea for months and even paid someone to research the business model before they moved.

At the start, though, nobody thought Uber would be worth much. The angel round came together easily, but $1.25 million was the normal size for one. The founders were not sure it would work either: they traded 2% of the company to Universal Music for the uber.com domain, and promised to give the domain back if the company folded. Had Uber listed at the $120 billion target, that 2% would be worth $2.4 billion — though the shares were bought back in 2011.

Uber meant no more standing helplessly at the curb; the phone brought a car whenever you wanted one. And anyone who could drive no longer had to become a professional driver to make money — they could use their own car and take rides when they felt like it.

The timing was good. The iPhone 4 arrived in 2009 and smartphones spread fast. While Zuckerberg still put the PC first, Tencent was still working out how to keep QQ strong, and Taobao did not set up a mobile division until 2013, Uber was already reading demand across a city from phone location data, with a wallet inside the app for quick payment.

Investors understood the business quickly — it was a service they used themselves. A few months after the first round, in early 2011, Benchmark, one of Silicon Valley's most important venture firms and a backer of Snapchat, Riot Games, Twitter and Tinder, bought into Uber's Series A for $11 million.

Surge pricing, Uber's invention for raising fares at busy hours, drew heavy criticism for a while, and Kalanick defended it flatly: it was simply supply and demand, pulling more drivers onto the road and getting riders a car faster.

Jeff Bezos, the world's richest man and Amazon's founder, said at the time: "Kalanick is a real entrepreneur. The average CEO would have backed down long ago." Bezos put money into Uber in 2012.

Bold, aggressive tactics ran through Uber's early years. To move fast into other countries, in 2011 Uber simply started operating in Amsterdam, Paris, Poland and elsewhere without licences, and lobbied the governments afterward. What it bought was very fast global growth.

Most of today's biggest startups began in those same years and grew with the smartphone. Wang Xing's Meituan raised a $12 million Series A in 2011 and opened the group-buying wars; Airbnb raised its Series A that year and began pulling apart the hotel business. A year later Cheng Wei founded Xiaoju Technology with 800,000 yuan and launched Didi Dache. Zhang Yiming, a veteran of several startups, put ByteDance together, launched Neihan Duanzi in March 2012 and released Toutiao three months later.

At this point Uber's fundraising and valuation were still modest: five rounds in four years, $307 million in all.

Meanwhile, Facebook went public in 2012, and after the early doubts and the early slide, its share price reached twice the IPO price by 2014.

After that, Uber began raising money as fast as everyone else. In 2014 alone it closed three Series E rounds; after opening a Series F in July 2015, it did five more rounds in a row. Corporate investors showed up — Microsoft put in $100 million, Baidu led a $1 billion round in Uber China — alongside private-equity money from the Tata Group, which invested $75 million.

Uber had a head start on all its rivals then. Didi was at home burning cash against Kuaidi Dache; in Southeast Asia, Grab was only two years old and still running its own taxi fleet. Uber was already in 311 cities across 58 countries. In the U.S., in the second quarter of 2015, Uber's ride count passed taxis for the first time. Going international multiplied Uber's revenue tenfold in two years.

Put money in, let Uber take more markets and more share, end with a monopoly and profits — that was why investors kept letting it burn cash. By the end of 2015 Uber had done 13 rounds and raised $8.2 billion, and its valuation had shot to $50 billion. In 2016 the Saudi sovereign wealth fund's $3.5 billion lifted it to $62.5 billion — the largest single investment Uber ever took.

But 2016 was also the year the problems surfaced. Ride-hailing had turned into a subsidy war fought with cash, and Uber lost $2.8 billion that year. And with the retreat from China, its potential market got smaller, not larger.

By 2017 investors were marking Uber down. Some would only buy shares at a $50 billion valuation. In November 2017 SoftBank paid $1 billion for new Uber shares at the earlier $68 billion price, then bought the remaining $9 billion from existing shareholders at a $48 billion valuation — which said plenty about what investors thought the company was really worth.

Uber was showing the same trouble as every unicorn of the era that swapped funding for growth: the money went out, the monopoly never came, and profit was further off still. Or the monopoly arrived, and the money it produced was far less than the money burned.

Snap, the star unicorn valued at $16 billion, showed its losses in the first earnings report after going public; the stock fell from a $17 offering price to under $6 today.

Stranger still was Theranos, the blood-testing company that promised to overturn medicine and the life sciences. When reporters found its core technology was faked, $9 billion in value vanished overnight and its founder was buried in lawsuits.

Magic Leap, which took $2.3 billion from Alibaba, Temasek and others, spent years on the Magic Leap One AR glasses and shipped something that bore little resemblance to the concept demo.

And Meituan, which has watched the whole history of Chinese internet cash-burning, came out of the thousand-team group-buying war, moved into food delivery and on-demand services, then started a ride-hailing business in 2017. Meituan, Dianping and Mobike raised $14.2 billion between them and still could not stop losing money. Its prospectus showed that Meituan, valued at $60 billion, had a net loss of 2.8 billion yuan as of the end of 2017.

Dropbox, Palantir, Pinterest and Zenefits are all the same. Each built the best product in its field and bought fast growth with big rounds, and each could not produce revenue to match its valuation.

A tech company did not always mean a high valuation. Google and Facebook changed what the world expected

The relationship between tech companies and money was not always what it is now, where you start by telling a story to raise money and then burn it for growth.

The early Microsoft and Apple both planned to sell products and fund their own growth — essentially the path of an ordinary company.

Bill Gates and Paul Allen wrote a BASIC compiler, and Gates went on the road himself to sell it. From founding to its 1985 listing, Microsoft never took a cent of venture capital.

Apple, founded in 1976, started out on hand-built Apple I machines. A year later it incorporated, and raised $600,000 only to get the Apple II into production. It needed nothing more: it sold Apple IIs all the way to the stock market. Apple's IPO raised $100 million — an unremarkable figure today, but at the time the largest public offering since Ford's in the 1950s.

Microsoft and Apple spread the personal computer, and Amazon (1994), Google (1998), Alibaba (1998), Tencent (1998) and Baidu (2000) all appeared in that stretch.

Then the dot-com bust of 2001 hit every one of them. Alibaba was at one point down to $7 million, enough for six months of operations. Amazon's stock lost more than 90% and the company scraped through on a loan taken out before the crash. Google and Tencent both have stories about nearly selling themselves.

It took these companies a few years to find a business model that worked, and they came out the other side.

The first company to change what outsiders expected was Google, which listed in 2004 after raising more, and at a higher valuation, than anything from the bubble years. Not long after, the financial crisis swept the world.

The change was completed by Facebook's listing in 2012. Facebook's IPO was a turning point for American venture capital: it is the only large tech company born after the dot-com bubble.

The Facebook model is today's internet model. Expand as far as you can, raise as much as you can, ignore losses, buy users. Like Google, it won a high valuation through the doubts and went public through the doubts — only much bigger.

On its first day Facebook was worth $104 billion, and then the stock fell below the offering price. Investors questioned a price-to-earnings ratio above 50 (market value against profit) and whether the company could keep growing once the mobile internet took off.

Two years later, Facebook answered every doubt with advertising revenue, and even after a bad year it is still worth more than $400 billion.

Set inflation aside: Google raised $36.1 million before its IPO, 29 times what Microsoft and Apple raised put together, and Facebook raised 44 times what Google did. The capital a company consumes before it lists keeps climbing.

No investor wants to miss the next Facebook, and all of them are happy to spend money to turn a startup into a unicorn faster. Facebook and Google convinced the capital markets to accept the sequence of users first, market share second, profit whenever — because surely the best company in an important field, holding a huge base of users, can carry a valuation in the tens or hundreds of billions?

Startups that once needed years to find a business model were forced to ripen. There is more cash in this industry today than at any point in the 1990s.

Uber, Didi and even Airbnb have each now raised more than Facebook did before its IPO. In the two years Uber and Didi fought head to head in China, both companies' rounds were counted in billions, even tens of billions, of dollars.

And in their first year in China, the bike-sharing companies Mobike and ofo raised 69 times what Didi and Kuaidi raised over the same stretch.

The new bubble keeps repeating itself in Silicon Valley. Lime and Bird, shared electric-scooter companies built on the bike-sharing model, are both planning $2 billion rounds next year. Both rose so fast that a little over a year after founding they were each worth $1 billion.

Lime reached $1.1 billion after a $350 million round led by Google Ventures; Bird, backed by Sequoia Capital, went as high as $2 billion — 2,000 times what Uber raised in its first year.

Then came the money with nowhere else to go

How much tech companies raise and how much they are worth reinforce each other along with the flow of money through the markets.

The U.S. has long been the world's largest venture market. After the 2008 crisis, the Federal Reserve cut rates seven times in a single year; by December 16 that year the policy rate was effectively zero (a 0–0.25% band), and it stayed there for a full seven years, the longest low-rate stretch in the Fed's history.

That meant money in a bank earned almost nothing, and borrowing from a bank cost almost nothing — an invitation to every industry to take on debt and expand. At almost the same time the Fed changed its monetary policy and put more than $4 trillion into the market by buying Treasuries, which pulled manufacturing, services, production and exports off the bottom.

The venture firms that had already made their names raised their bets. Andreessen Horowitz (a16z), an investor in Skype, Facebook, Instagram, Twitter and Airbnb, began putting tens of millions into Series A rounds rather than waiting for a company to grow.

In 2014 a16z led a $6 million round in Product Hunt, an app-sharing and recommendation site whose only full-time employee was its founder. a16z's seed investment in Instagram had been just $250,000.

Mutual funds, which had rarely gone into venture deals directly, also started buying into tech companies. These funds pool small investments and are run by professional asset managers, and they used to care above all about safety — and startups are obviously not safe.

But a Harvard Business School paper points out that mutual fund houses such as Fidelity and BlackRock were in fact the biggest backers of Uber's early rounds.

The authors also note that startup financing has changed enormously in recent years. These companies once drew on a handful of VC firms; now the sources have widened greatly, and mutual funds, sovereign wealth funds and family offices that used to buy listed stocks have joined in. Because these institutions manage tens of billions or even trillions of dollars, more mature companies have put off going public.

China Investment Corporation, China's sovereign fund, led a $4.5 billion round in Ant Group in 2016 and followed on in several rounds after that. Temasek, wholly owned by Singapore's Ministry of Finance, joined a new round this year that came to $14 billion. And the Saudi sovereign wealth fund, having already put $3.5 billion into Uber in 2016, went on to put $90 billion into SoftBank's Vision Fund.

Corporate venture arms supplied the market with ammunition too. By CB Insights' count, corporate investors did $8.4 billion of deals in 2012. Two years later that had doubled, and in 2015 it grew almost 70% to an unprecedented $28.4 billion. In 2009 the figure had been only $5.1 billion. As of the last quarter of 2016, 63% of corporate venture money was going into internet and mobile.

Walmart spent $3.35 billion on the largest e-commerce acquisition in U.S. history, buying the pet-supply retailer Chewy.com, and this year has been in talks to spend $15 billion for control of Flipkart, India's largest e-commerce company. Inside tech, Magic Leap took several rounds from Google, Alibaba and Qualcomm.

Looking back, the rise of the mobile internet, the overseas profits piling up at big American companies and cheap borrowing all pushed corporate investment arms to send more money to startups. Microsoft's enormous return on the $240 million it put into Facebook in 2007, and the early bets GV, Google's investment arm, made on Uber and a string of others, are the models for corporations force-feeding startups.

China did something similar — policy incentives plus corporate money — which raised both the speed and the density of capital.

Alibaba Capital was set up in mid-2008 and steadily increased its investments in e-commerce, enterprise services and elsewhere, from 22 deals in 2013 to 96 in 2018, more active than many top-tier VCs. Xiaohongshu, Didi, ZhongAn Insurance and China Unicom have all taken Alibaba's money.

Tencent has invested in more than 600 companies in the past seven years. On January 24, 2011 it announced the Tencent Industry Win-Win Fund, initially 5 billion yuan and later topped up to 10 billion; within six months it had put out nearly 3 billion yuan, at a time when Tencent's annual profit was only 8 billion yuan. Today a whole cohort of listed companies — Meituan, Pinduoduo, Huya, China Literature and others — are either close to 20% Tencent-owned or were incubated by Tencent outright. Last November the combined market value of Tencent-linked companies briefly amounted to 12% of the Hong Kong exchange's total.

Startups with money of their own started investing too. At the end of September 2016, ofo announced a strategic investment of tens of millions of dollars from Didi.

"Mass entrepreneurship and innovation," the slogan introduced at the 2014 Summer Davos, marked the start of China's policy tilt toward venture capital. To grow local economies and attract outside money, cities including Beijing, Shanghai, Shenzhen and Chongqing taxed the partners of venture firms at a preferential personal rate of 20%.

After 2015, fundraising by Chinese equity funds — early-stage, venture capital and private equity alike — grew wildly. Zero2IPO Research data shows that against 2014, last year saw 379.7% more new funds set up and 249.5% more money raised. A PwC report adds that in 2016 yuan-denominated funds accounted for more than 75% of the total; in 2017 the share reached 86.5%.

There has in fact been less genuine internet business-model innovation in recent years than there was around 2010. But far more money has poured in, and the direct result is that valuations at the front of the pack have soared.

New share structures and investment terms outsiders never see make investors readier to hand out high valuations

When Apple went public in 1980, the 45% Steve Jobs held when he founded it had been diluted to 15%. After a fight with the board, he was thrown out of his own company without much trouble.

That is unlikely today, because with dual-class shares the same 1% held by a founder can carry ten times the votes of an investor's.

Which means a founding team can sell far more equity without putting its own control at risk.

When Google listed in 2004, Page, Brin, Schmidt and the other core executives held 37.6% of the shares and 61.4% of the votes. Zuckerberg and Richard Liu are both examples of one person controlling a whole company with a minority stake. Snapchat, which listed in 2017, went further and created three classes of stock; the Class A shares sold in the IPO carried no votes at all and could be sold to the market in full.

More money usually comes with a higher valuation. So internet companies have more stock to trade for round after round, pushing the valuation up while making sure nobody gets pushed out of the boardroom the way Jobs was. According to the San Francisco firm Sutter Securities, 1% of U.S. listed companies had dual-class shares in 2005; ten years later it was 15%.

But not every lopsided term in an investment agreement favors the founder the way dual-class shares do.

In the essay where he flagged overheated unicorn valuations, Bill Gurley noted that to protect their returns at exit, venture investors write a set of lopsided clauses into their contracts: first claim on the proceeds if the company goes under, a veto over major decisions.

In 2015 the mobile security startup Good sold to BlackBerry for 38% of its last-round valuation. Employees then discovered that the contracts with the venture firms gave their stock a liquidation preference: each investor share paid out seven times what an employee share did. So although Good had shrunk 62%, even the last investors in lost only about 30%. The employees came out behind — the tax they had paid when they received the shares was far more than the shares were finally worth.

Investors now routinely use this structure of preferred payout plus participation. Even if a company goes bankrupt with no profits, they still get first claim on whatever the auctions and collateral bring in.

Convertible notes have also become an important early-stage instrument for American startups. PitchBook counted convertible notes in about 19% of U.S. venture deals in 2015, the highest in a decade. The note converts into preferred stock when the debt matures or when the startup closes its next round.

That lowers the venture firm's early risk, and these contracts commonly let the investor convert at a 20% discount to the next round's price as compensation for taking it. All of these protective clauses have pushed still more money toward internet companies, and driven valuations up round after round.

Going public is not the finish line. The cash-burning giants reaching the market now still have to prove they are more than one move in a capital game

The internet's easy growth is gone and smartphone sales are slowing, so internet startups are running into slower growth, and the capital that came in round after round needs to get out with a profit. A whole cohort of tech companies that bought growth with other people's money has rushed to list this year.

As of December 4, 2018, 128 Chinese companies had listed in Hong Kong and 32 in the U.S., most of them internet and tech companies.

But going public is not the finish line, and nearly all of them have fallen below their offering price. Meituan trades at 75% of its IPO price; Spotify at 76% of its opening price (it listed directly, with no offering price); Snapchat at 34%. Pinduoduo, iQiyi and Dropbox now sit roughly at their offering prices, after roller-coaster drops on the way.

Some companies will not last long enough to list. ofo is now signing users up for peer-to-peer lending platforms to find the money to refund their deposits, while Theranos, the biggest startup fraud in America, has been reduced to a Hollywood script.

Poor performance after listing hits confidence directly. Early this year Huya Live, part of the Tencent camp, rose as much as 400%, and China Literature doubled within an hour of its debut. But as game regulation changed, Tencent's own market value fell almost 43% from its peak this year, dragging down more than ten newly listed companies it holds stakes in.

Now the company with the highest valuation, the most money raised, the largest revenue and probably the most real innovation in the whole cohort is going public. Just as Facebook once set the market's optimism about internet companies, how this bellwether performs could be the point at which sentiment turns fully pessimistic.

This is not the end of the industry. When the dot-com bubble burst in 2000, at least 4,854 internet companies worldwide were acquired or folded. But Amazon, Priceline, PayPal, China's three big portals, Baidu and others used the money they raised in their listings to get through the worst of it, and then grew for a long time after.

Now it is the turn of the companies raised inside the new bubble to prove, once listed, that they are a business that lasts and not simply one move in a capital game.

Graphics / Xiuxia Feng, Shuya Zheng Data / Fangyi Gong, Shaohong Zhou, Jinping Xie

Cover image: Photo by Kevin Schmid on Unsplash