Tag Archives: Silicon Valley unicorns

David Stockman: Amazon And The Fantastic FANGs…

A Bubblicious Breakfast Of Unicorns And Slippery Accounting

Consider the case of Amazon. Its PE multiple on LTM net income of $328 million has dropped from 985X all the way to…….well, 829X! Likewise, it’s now valued at 97X its $2.8 billion of LTM free cash flow compared to 117X at year end.  In the same vein, Facebook’s LTM multiple on net income has dropped from 108X to 96X.

So the reason to revisit the FANGs, and the Amazon bubble in particular, is not because their market caps have come down to earth; it’s because once you get inside, another characteristic of late stage bubbles comes lurking front and center. Namely, the tendency for the accounting income of momo tech stocks at bubble tops to be bloated with non-sustainable revenues and profits from Silicon Valley burn babies…

…I was reminded of this possibility by an excellent post by Dave Kranzler at Investment Research Dynamics. In a piece called “AMAZON dot CON” he took me to task for being too kind to Jeff Bezos’s ponzi accounting.  Among other things, Kranzler went all the way back to the beginning and offered an even more dramatic juxtaposition of the bubble in the stock versus the reality on the ground:

Throughout its 25-year history as a public stock, AMZN has delivered a cumulative total of $1.9 billion in net income to shareholders. Jeff Bezos made $16 billion on AMZN stock in 2014.

You can read the rest of Stockman’s commentary on AMZN here:  Amazon And The Fantastic Fangs

The Square IPO Just Caused Pensions To Become Even More Underfunded

The Square IPO is an event that will deliver a big blow to Silicon Valley private equity valuations and further exacerbate the already near-catastrophic condition of most, if not all, pension funds.

It’s been well publicized that most, if not all, State pension funds are moderately to significantly underfunded.  Notwithstanding the fact that States have been “borrowing” cash from these funds in order to pay for State and local Government spending deficits, every pension fund has been earning significantly lower rates of return on its asset base relative to future benefit funding requirements.

The math is pretty simple.  Every pension fund, public and private, has an established (actuarial) forecast of future benefit outflows vs. fund member contributions and invested capital earnings.  Most, if not all, pension funds have been assuming either a long term ROR of 7.5% or 8% on assets.  This is the rate of return required every year in order to fund the long term beneficiary payment obligations.  Every year that a fund underperforms its 7.5/8% “hurdle” rate of return is a year in which the fund becomes more underfunded.

Pension funds were disastrously underfunded after the stock market crash that bottomed in the spring of 2009.  Most pension funds are allocated 60% in fixed income and 40% in equities, real estate, alternatives.  Even with the “remarkable” move in the stock market over the last five years, and because fixed income has returned almost nothing over the time period, pension funds never were able to dig out of the “hole” created in 2009.

Most of them over the past few years have chased returns by literally shoveling money at private equity funds and speculative real estate funds.  The investments which do not have continuously observable markets in order to evaluate pricing and appropriate market-to-market are perfect for these funds because they can mark up their private equity and real estate investments quarterly based on “mark to model” pricing assumptions.  On the flip side, they can drag their feet on marking these investments down when those asset classes head south.

Keep in mind that many of these funds were never properly marked down to market after the financial crisis, so when you hear Calpers or the Illinois State Retirement fund is 40% or 50% underfunded, on a true mark-to-market basis it’s probably closer to 60% or worse.  All the accounting games used by corporations are also used by corporate and public pension funds.

Several pension funds are now allocating as much as 20% of their capital to private equity funds.  Most of this money is invested in Silicon Valley, biotech and real estate.  Biotech has already been crashing.   Real estate is starting to crash.

And it looks like the private equity Silicon Valley bubble is now popping.  The valuations became absurd, as small start-ups with no revenues were routinely valued in the billions, based ridiculously on, say, a $10 million dollar funding that valued the entire business on paper at $1 billion.  It was, to say the least, retarded.

But along with the soaring paper valuations, private equity fund valuations were marked up to fairytale levels and long with them the value of pension investments in these funds.

It looks like all of that has changed now, as the highly touted Square IPO was priced yesterday 42% below its last round of private equity funding.   Think about what this means.  It was only a matter of time before Silicon Valley “unicorn” slow motion train wreck ran out track and hit a wall.  This is an utter disaster for the pension industry.

Naturally Jim Cramer, who probably has not even bothered to look at any part of the Square deal or its related documentation and instead is vomiting out the smoke blown up his ass by his hedge fund cronies, has issued a strong buy on Square.  This will be the final kiss of death for this stock.

I’m not saying that Square doesn’t have intrinsic value.  Surely it does as it actually is a real business with real revenue, although the revenues are slowing and the losses are growing. But what does this say about all the companies in private equity portfolios that have been assigned huge bubble valuations and don’t have revenues?  Mark them down at least 60%.

The point here is that now big pension funds, which are already underfunded, just become even more unfunded with the mark to market event provided by the Square IPO.  While these pension funds will drag their feet on marking down their private equity investments, this reality is going to get worse over time and these funds will become insidiously underfunded.

And then what happens if the Fed does raise rates, which will knock down fixed income and stock investments?   Lights out.  And, by the way, everything I just said about public pension funds also applies to corporate pension funds, some of which are likely even more underfunded than their public counterparts.