Multiple Compression In The "Winter" & Why It Matters

To say that today was a rollercoaster would be an understatement. While I recognize I'm a relative novice to the financial markets, watching fast selloffs and panic selling is always mesmerizing - no matter how many times one has seen it. I don't know how Bill Gurley always seems to have impeccable timing, but last Thursday night (before Friday's market pullback which started this whole mess) he ripped off an 8 piece tweetstorm where he warned that recent corrections in the public markets could have an adverse impact on the tech startup world. Re/code chronicled those thoughts in a piece entitled Winter is Coming, You Ready? Within the tweetstorm, Gurley made the following two points:

3/ The bottom line is that global tech valuation multiples are compressing (coming in). Quickly.

— Bill Gurley (@bgurley) August 21, 2015

5/ If so, we may be nearing the end of a cycle where growth is valued more than profitability. It could be at an inflection point.

— Bill Gurley (@bgurley) August 21, 2015

At the close of today's markets, I decided to do a quick analysis to see how true that is. Especially with a few of the stocks I know very well: marketplaces such as Etsy, Grubhub, Shutterstock & Homeaway. As some of you may recall, I penned Unpacking Etsy's S1 on TechCrunch a few days ahead of its IPO back in April. Here's how those stocks stacked up back then on a GMV, Revenue & EBITDA basis -

Etsy11

Recall that on the day of its IPO, $ETSY actually spiked to an Enterprise Value of over $3 billion dollars so imagine an EV/GMV of close to 2x and an EV/Revenue of nearly 15x.

I re-ran the numbers at the close of today's market and updated the company financials to reflect their trailing twelve months (2nd half of 2014 & 1st half of 2015) as opposed to just 2014. Here's what they look like now:

Etsy13

As is evident, Gurley is 100% correct. Its not these companies aren't growing (see below) its that their multiples have been cut by 50-65%. Only Homeaway seems to have avoided the carnage, most likely because it is the eldest, most profitable, with the strongest balance sheet. At the same time, to those of us in the tech world, it is the stock most likely to be entirely disrupted - by Airbnb - but no matter. The market is looking for stability, not growth. You can see for yourself: the market is applying nearly identical multiples to both Etsy & Homeaway - two companies at very different stages of growth and maturity.

Here's why this matters: Most VCs (including Chicago Ventures) have typical rules of thumb we like to apply to companies when considering an investment that have (at least roughly) some correlation to public market comparable. For example for marketplace businesses, we've historically looked for a valuation to be anywhere from 1.5-3x annualized GMV. For an e-commerce business it might be similar. Its dependent on growth rates, and we expect to pay higher than public market multiples because our startups are growing 2-10x year/year, not 60%. But as public market multiples come in, we're forced to reevaluate. For instance, if we're considering a Shutterstock clone (bad example, but you get the point) and we're forced to say - "Well, it really only has $800M market potential, not $2.5 billion potential" - then it drastically affects entry price.

How long current multiples will last is anyone's guess - or whether they'll have a snap correction. But one thing seems clear to me right now: my generation of younger VCs who were trained to assess top line GMV growth first will soon be forced to master other, more fundamental aspects of a business' economics.

For those keeping score at home, here's my assessment of those 4 public co's trailing twelve month financials. I moved quickly to get this out the door before the market close & there could well be errors:

Etsy14