Capital drought will spark unicorn M&A orgy

December 23, 2015

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A capital drought may stimulate an orgy among unicorns. Plentiful money has detached valuations on many hot private tech firms from reality. There are 144 of these private companies worth $1 billion or more according to CB Insights. Curiously, about a third are valued at $1 billion on the dot. As capital becomes more expensive in 2016, selling to rivals or mating with other unicorns will become appealing.

Few of these young companies are cash-flow positive, so most will need capital infusions to survive. That money may be drying up. Fidelity Investments recently marked down the value of its Snapchat and Zenefits holdings, and BlackRock slashed the value of its Dropbox stake. If massive asset managers pull back, private firms will be dependent on tinier venture capital outfits, which may be more demanding in their terms. Even hardened angel investors are becoming skeptical. Marc Benioff, Salesforce.com’s founder, says he will no longer invest in unicorns because they have “manipulated private markets to obtain these values.”

Going public is an option. American tech firms’ proceeds from initial stock sales so far this year are $6.1 billion – a fifth the amount they raised last year, according to Thomson Reuters data. Global trends are similar.

Claims that remaining private allow founders to retain a long-term focus look suspect. Super-powered voting stock allows insiders to treat public companies as their fiefdoms. But the stretched private valuations make it harder for unicorns to go public. Insiders do not want the ignominy of a so-called down round. Floating at a reduced price also creates the impression something has gone wrong. That can make it difficult to lure customers and talented engineers.

M&A may be a better option. Two of China’s private taxi apps, Didi and Kuaidi, combined in February to gain scale against Uber, and the combined valuation ballooned. Didi Kuaidi recently invested $100 million in U.S.-based Lyft. Lyft could seek shelter from Uber by selling itself to Didi Kuaidi or partner Hertz. Other unicorns that have run into trouble could also find comfort in the arms of bigger, more mature rivals. Benefits manager Zenefits might make a nice target for Workday or ADP. It’s easy to see how cloud storage firm Dropbox might drop nicely into the portfolio of Microsoft.

Insiders may not wish to sell at public market valuations. Tacking on a change-of-control premium would help narrow this gap. And a lack of cash flow and scarcer private capital may eventually force their hands.

This view is a Breakingviews prediction for 2016. Click here to see more predictions.

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