The Black Swan Pushes Events to the Tipping Point- Maximizing Enterprise Value in the upcoming Crisis |
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This article was published by Steven R. Gerbsman and Robert Tillman in May, 2007
and again in August, 2015. It appears it may be “that time again”. Please read, enjoy and “be prepared”. Best regards, We are currently in one of the best economic times in our country’s history. The stock market is at all time highs, unemployment is at all-time lows, interest rates are low, money is plentiful and deal valuations are high and getting higher. There are, of course, many worrisome trends: terrorism, excessive government spending, trade deficits, high oil prices, immigration and over the longer term, such issues as an aging population and (possibly) global warming. Although problems and worries always exist, in historical terms, times are very good indeed. The big questions for us as specialists in maximizing enterprise value are: Will it end? Yes. Of course. Even fundamentally healthy economies experience frequent and often violent corrections. The current world economy has evolved in many ways over the past decade. All large businesses are international. The primary economies of the world are very tightly linked together. Money is far more liquid and moves around the world with far less “friction” than it did in the past. The pace of technical change continues to increase. Nevertheless, we do not believe that the laws of history, and especially, the laws of human nature, have been repealed. As always, “The more things change, the more that they remain the same.” When will it end? Unfortunately, no one knows the answer to this question. In historical terms, the current economic expansion has continued for a very long time and has survived numerous shocks, including war, a doubling of energy prices, natural disasters and localized economic downturns, such as the bursting of the sub-prime mortgage bubble. It appears to be “ripe” for a downturn. On the other hand, inherently unstable situations often persist for far longer than anyone could believe possible. During the 2000 Internet bubble, it seemed to us for quite some that the old rules of business no longer applied and that 25 year-old CEOs knew something us old guys did not know. When the crash occurred, we were relieved to find out that we were not so obsolete after all. We did, however, underestimate the staying power of technically insolvent companies with broken or non-existent business models. Many of these companies had significant cash on the balance sheet (offset, of course, by significant liabilities) and investors who continued to infuse more cash far beyond the point of reason. Today, there exist immense pools of uncommitted cash, much of it in the hands of entities, such as private equity funds and hedge funds that are subject to minim al regulatory scrutiny and whose operations are obscured from the public view. In addition, the weakness of the dollar against both the Euro and the Pound Sterling makes U.S. assets a relative bargain. These factors tend to mitigate against an economic downturn. For how much longer they will continue to do so we do not know (and if we did know, we would certainly would not tell). How will it end? Fast, hard and unexpectedly. Two recent books shed a great deal of light on the process: The first book, The Tipping Point by Malcolm Gladwell describes how human behavior causes events to cascade rapidly once a certain critical mass (the “Tipping Point”) has been achieved. Examples in the business world include periodic economic ?panics? and the spread of certain technologies and products, such as personal computers, iPods, cell phones, etc. It is very difficult to predict in advance when the ?tipping point? in any situation will be reached, but history has shown that, once it has been reached, events proceed very quickly. The second book, The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb describes how highly improbable, and hence unpredictable, events periodically create massive change. The title of the book derives from the observation that the existence of even a single black swan disproves the assertion that all swans are white. Historical examples include the Fall of France at the beginning of World War II, the rise of the Internet and 9/11. There are many obvious candidates for a “black swan” event that pushes the world economy over “the tipping point” into a downturn – a war with Iran, a nuclear terrorist attack or a worldwide bird flu or small pox epidemic, but generally, it is what you do not see that gets you. We are fundamentally optimists about the long-term prospects of the world economy. In many highly measurable ways, the wor ld really is improving, driven by technological innovation, a lowering of barriers to trade and increasing economic integration. Nevertheless, we are old enough to have lived through many “bumps” along the road and know that such discontinuities will always occur. We believe that we will see a significant economic event sometime over the next 12-18 months, either localized to a particular sector or geographic region or globally. Our Advice? Before such an event occurs: As a board member, investor or stakeholder:
When such an event occurs:
About Gerbsman Partners Gerbsman Partners focuses on maximizing enterprise value for stakeholders and shareholders in under-performing, under-capitalized and under-valued companies and their Intellectual Property. Since 2001, Gerbsman Partners has been involved in maximizing value for 98 technology, medical device, life science, digital marketing/social commerce, fuel cell, consumer and solar companies and their Intellectual Property and has restructured/terminated over $810 million of real estate executory contracts and equipment lease/sub-debt obligations. Since inception, Gerbsman Partners has been involved in over $ 2.3 billion of financings, restructurings and M&A transactions. Gerbsman Partners has offices and strategic alliances in San Francisco, New York, Boston, Orange County, VA/DC, Europe and Israel. |
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Once-flush start-ups struggle to stay alive as investors get picky
- Eighteen months ago, Beepi was rapidly expanding its online used-car business to 16 US cities where people could buy cut-rate vehicles adorned with giant shiny bows.
Beepi doesn’t exist anymore. After burning through more than $US120 million ($158m) in capital, the start-up failed to raise more cash and shut down in February. Its roughly 270 employees cleared out of the cavernous Mountain View, California, headquarters leaving behind the ping-pong table and putting green.
Beepi’s rapid demise offers a glimpse into the changing fortunes of Silicon Valley start-ups, many of which struggled to adjust as a two-year investment frenzy came to an end.
In 2014 and 2015, mutual funds, hedge funds and others pumped billions into companies that they now see as overvalued, and unlikely to pull off an initial public offering. As venture capitalists became more discerning, investment in US tech start-ups plummeted by 30 per cent in 2016 from a year earlier.
For some, demand is still robust. Much of the money still being invested is pouring into the upper echelon of highly valued start-ups like Airbnb and WeWork or younger ones with clear paths to profit.
“There are companies that everybody wants to invest in and there are a large set of companies that almost nobody wants to invest in,” said venture capitalist Keith Rabois of Khosla Ventures.
Venture capital firms remain flush with cash. They raised $US44 billion last year, the most since the dotcom boom.
But investors are staying away from scores of well-funded start-ups that once looked like relatively safe bets, forcing these companies to fight for survival as they burn through their stockpiles of cash and scramble for new money or buyers.
“They’re like the walking dead,” said David Cowan, a partner at Bessemer Venture Partners, who expects a steady stream of failures.
In 2014 and 2015, more than 5000 US tech start-ups collectively raised about $US75bn, according to Dow Jones VentureSource — the largest amount in a two-year period since the dotcom boom.
Much of that money went to a small share of tech start-ups: 294 such companies raised at least $US50m apiece. Almost three-quarters of those companies — 216 — have neither raised money nor been acquired since the end of 2015. Such companies tend to raise funding every 12 to 18 months.
Seemingly every week lately, a well-funded start-up is slashing jobs or pulling the plug. In recent months, mobile-search start-up Quixey shut down after raising more than $US100m, health-benefits broker Zenefits — which raised more than $US500m — laid off nearly half its staff, and blogging platform Medium cut one-third of its employees after raising $US132m.
Such closures and cutbacks were rare two years ago when venture capitalists encouraged start-ups to expand rapidly to edge out competitors. Then when capital became scarcer, investors urged companies to turn profitable, which isn’t easy.
Take start-up Luxe Valet, whose app lets people summon parking valets in bright-blue track jackets. Founded in 2013, the San Francisco company had by early last year had ploughed into eight markets and raised more than $US70m.
Two competitors shut down. But expensive contracts to park cars in garages in big cities like Boston soaked up Luxe’s cash, according to a person familiar with the finances. The start-up has had to retreat to three markets. Luxe didn’t respond to requests for comment.
“There’s going to be a shake-out” for companies that can’t show a profit, said James Beriker, the chief executive of meal-delivery service Munchery. Mr Beriker joined the company in January after a rocky period that resulted in top executives leaving, including the co-founders.
Munchery, which has spent much of its $US120m in funding, is raising a $US10m lifeline from existing investors. The company is cutting costs and aims to be profitable by year-end.
For Beepi, profitability proved too distant for investors to wait.
Founded in 2013, Beepi caught on in San Francisco by giving people a fail-safe way to sell used cars online. Beepi guaranteed sellers a price, and if it couldn’t find a buyer in 30 days, it purchased the car. Beepi marked up the price and pocketed the difference.
Venture capital poured in, and its valuation surged from $US12m in early 2014 to $US525m by mid-2015. Beepi moved out of its cramped office and into a glassie building where the chief executive zipped around on his own Segway. Staffers enjoyed quinoa salad and turkey meatball lunches and dinners when they often stayed late, and unwound with ping-pong or Nerf guns.
The company’s strategy was a common one: blanketing the US to thwart competitors rather than focusing on a few cities.
Beepi spent a fortune to entice buyers and sellers through radio and Facebook ads, spending an average of $US1730 on advertising per vehicle in most of its markets.
Beepi was whipsawed by cars that sat unsold for a month, and that Beepi therefore had to purchase. Losses on those cars could reach more than $US5000 per high-end car, former employees said.
Revenue for the first half of last year was $US50m, up about 40 per cent from the previous six months. But with little revenue from add-on services like car repair, Beepi was losing up to $US5m a month last year, the documents show. Costs were falling, but profitability wasn’t forecast until 2018.
By mid-2016 CEO Ale Resnik hunted for cash to stanch the losses, but investors were spooked. Most of Beepi’s staff was laid off in December.
Employees say they believed the business would have proved sustainable if they were given more time.
“It was clear to us internally how to get there,” said Tyler Infelise, Beepi’s head of product.
The Wall Street Journal