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A lesson for early stage businesses: The market can see through real disruption!

Over the past 2 years we have seen a series of so called technology unicorns in their private valuations going public. There was a lot of enthusiasm and energy in anticipation. Each of these stocks were oversubscribed significantly. But what has really unfolded is quite the opposite.

As mentioned above, over the past 2 years while we have seen a series of so called technology unicorns in their private valuations going public and there was a lot of enthusiasm coupled with energy in anticipation, resulting in each of these stocks being oversubscribed significantly, what has really unfolded is quite the opposite. The below graph summaries the same:

Returns of stocks for the last 12 into 1st Feb 2020 vs. the performance of NASDAQ. Source

When we looked deeper into why some of these unicorns that listed themselves, didn’t really outperform the NASDAQ performance in terms of returns, we find two key reasons for the same:

  1. Aggregators are not necessarily disruptors — As per Peter Thiel, true disruptors make things go from 0 to 1. Consider Louis Vuitton vs FarFetch; while FarFetch largely aggregates, Louis Vuitton keeps innovating with its own designs. Yes FarFetch did make the accessibility to luxury goods much more easier for HNIs and UHNIs, but it’s underlying business model didn’t suggest that it created sufficient MOAT for itself. Given leading brands that have top of mind recall such as Louis Vuitton, are globalising while digitising access, FarFetch has a lot to do to remain differentiated and provide sufficient reason for charging premiums in its path to profitability. To that extent, Louis Vuitton has seen its share price rise by 39% over the past year while FarFetch has seen its share price plunge by 38% during the same period. Similarly, while Louis Vuitton has been reporting strong financial performance and profits for the past couple of years, FarFetch has been reporting losses after tax for all of 2018 and 2019 YTD. More details on FarFetch financials can be found here.

  2. There are no shortcuts to growth — Just market share via deep discounting and aggregation, without underlying true innovation is not much appreciated. Consider Uber vs Tesla; while Uber aggregated, Tesla disrupted the electrical vehicles marketplace. Yes Uber did make the marketplace for cabs more efficient, but it’s underlying business model and financials does give a sense that somethings got to give — with 10 out of the last 11 quarters in losses, Uber now needs to identify ways to make money. At the end of the day businesses are in business to make money; and quickly at that. Tesla’s sheer innovation, and so in the case of Apple, allows these companies to charge premiums the way they do (or provide sufficient reason to move to a profitable state), without compromising on market share. Note that Tesla too was non profitable for a large part of the period since it went public until the last couple of quarters. It’s cash position has been significantly improving at the back of revenue growth fuelled by innovation and cost consolidation. To that extent, Tesla saw its share price surge by 100% over the past year, while Uber saw its share price drop by 12.7% during the same period.

In Conclusion

The market knows over a period of time as to which companies are truly disrupting and creating economic value without jeopardising their financial position (and in case of current losses, having clear & believable paths to profitability), versus those that are just aggregating / globalising and offering discounts to expand market share — thereby only disrupting robust industries towards bankruptcy.

To that extent, it is imperative for early stage businesses to ensure that their growth is based on sound business fundamentals, creation of new markets, product differentiation, and further backed by positive unit economics (as against just aggregation and deep discounting). Such an approach will bolster their intrinsic stock value, and therefore make them lucrative investment options for investors (based on margin of safety principle).

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