The Ripple Effects... Accelerated

May 31, 2022

Sometimes economic cycles move too quickly .

So quickly... that many companies are caught flat-footed.

You see, non-profitable companies are at the whims of those who are willing to lend them money.

When the confidence of those creditors fades — watch out.

Money that was so easy to raise just 9-12 months ago is gone.

We’ve written about the ripple effects of liquidity drying up before.

As a refresher, here’s what we said April 5th in The Ripple Effects:

“The fallout of the bust in growth stocks has made its way into private companies.

The valuation multiples on publicly traded growth stocks have compressed by 50-75%.

Many companies were trading at 20-30x sales last year.

Now they’re trading at 5-10x sales.

What does that mean outside the obvious carnage in losses amongst public investors?

It means private company investors – and the private companies themselves – are about to feel the pain. Big time…

Hundreds of companies eyeing an IPO are now holding their breath hoping the public markets get back to their highs.

If not, they’ll have to raise a down round. Cut costs and conserve cash. Or worse.

The private investors in these companies are now “stuck” with no liquidity event on the horizon.

Now, private investors will give less money or give lower multiples.

Less money and lower multiples mean less hiring. Less capital investments. And so on.

This, in turn, circulates through the economy… continuing a negative feedback loop.”

We called out grocery delivery company, Instacart, who just raised money at a 40% haircut to its previous round. Its valuation dropped from $39 billion to $24 billion.

An Instacart spokesperson said in a statement to CNN Business in March that the company is, “confident in the strength of our business, but we are not immune to the market turbulence that has impacted leading technology companies both public and private.” (emphasis added.)

We also called out technology company, Fast. Fast was worth $1 billion with hundreds of millions in cash on the books during January 2021. They ran out of money last month.

They didn’t adapt... and, as a result, died. They’ll be a textbook case-study of what not to do in the future.

But this is just the start…

Substack — the company powering our emails, like the one you’re reading right now — just announced they stopped looking to raise money altogether because of the market environment.

Substack was looking to raise $75-$100 million. Not anymore.

We can’t emphasize enough how much of a signal that is.

Substack didn’t try to raise less money or a down round.

They stopped trying to raise money altogether.

Meanwhile, Just Eat Takeaway is looking to take a $5 billion writedown on Grubhub — which it bought for $7.3 billion just one year ago.

A $5 billion loss in one year. Ouch.

But those are examples from the company’s perspective. There’s two sides to a transaction. Remember, there’s lenders on the other side of the table.

You’d think investors and/or lenders are now able to go bargain hunting.

Instead, they’re also battening down the hatches.

Top private equity investment firms Y Combinator and Sequoia have given their investment companies the red alert signal to cut costs or face a ‘death spiral.’

SoftBank – a company who raised a $100 billion venture fund a couple years ago – just announced they’re cutting investments by 50-75%.

Here’s SoftBank’s Chief Executive, Masayoshi Son, on the matter (from Protocol):

“It depends on our LTV levels and investment opportunities, and we strike balance, but I will say compared to last year, the amount of new investments will be half or could be as small as a quarter,” said Son, according to a company-provided translation of the call.

This sounds like a good move by a solid operator… lest we forget SoftBank was investing tens or hundreds of millions of dollars in companies within as little as 10 minutes of hearing their ideas.

Want to guess who the largest investor in WeWork was?

It’s no surprise SoftBank recently reported a loss of $20.5 billion at its Vision Fund for the last fiscal year.

That’s what happens when all of your investments are based on interest rates being zero. When the cost to borrow money is effectively free. When investors believe companies can sacrifice profits forever as they grow to the sky.

That’s what happens when the paradigm of investing changes.

All companies — public and private alike — are now shifting their focus to profitability over growth.

That’s a good thing… for the company and its shareholders.

But not necessarily for the economy.

Profitability over growth means less spending on discretionary goods. Less capital expenditures. Job losses. Etc…

It’s why you’re hearing more and more murmurs of a recession.

We spoke about who the winners will be in our May 10th missive, Which Companies Will Make It Through.

The benefit of being a public investor is knowing who these winners are and getting the chance to invest in them at great prices.

Although we think the probabilities still skew to the downside… There’s plenty of great companies out there. You’re given a chance to invest in them at levels most thought we’d never see again. Time to start looking to add them to the portfolio.

Good investing,

Lance

P.S. Longtime readers know we’re actually more cautious on the market. So we’re not suggesting going all in by any measure. In fact, you should only invest as long as you’re able to sleep well at night. But some companies are trading at incredible levels.