(Bloomberg View) -- At Uber Technologies Inc., chaos reigns. The ride-hailing company’s investors forced Chief Executive Officer Travis Kalanick to resign earlier this month, and much of its C-suite is now empty. Meanwhile, Uber is being sued by Alphabet Inc. (Google) in a high-stakes lawsuit over self-driving car technology, and the company is still suffering the fallout from explosive revelations of a sexist corporate culture. On top of these problems, the company continues to lose billions of dollars a year, putting the viability of its core business model in doubt.
So with all these problems, Uber’s sky-high valuation must have taken a big hit, right? If it were a public company, Uber’s stock price would almost certainly have fallen in response to the relentless parade of negative news. But here’s the catch: Uber is a private company, so no one knows how much markets really value it. The number most commonly quoted in recent months is $69 billion, rounded up to $70 billion. Its last major funding round was in June 2016, when it took $3.5 billion from Saudi Arabia’s Public Investment Fund at a valuation of $62.5 billion. But that was a year ago, before its troubles began.
With private funding rounds so rare, Uber’s valuation has to be inferred from the secondary market -- i.e., people trading shares of Uber with each other over the counter. But because these markets aren’t public, the prices people are paying are hard to know, and must be inferred from rumor, anecdote and proprietary data gathered by various companies. TechCrunch reports scuttlebutt that places the value of Uber shares on this murky secondary market at $40 billion to $50 billion, which would imply a major, though not catastrophic, decline from the peak.
But even this secondary market doesn’t really tell us how much the average investor values Uber. The reason is a lack of liquidity, a feature of all private markets. Unlike liquid public markets, where shares are traded on centralized exchanges and public prices are updated continuously and available for all to see, private shares require buyers and sellers to hunt around for each other. Some sources report that buyers for Uber stock are getting hard to find:
"The demand side has dried up relative to the sell side," said Larry Albukerk, managing director of EB Exchange, a San Francisco broker that has arranged private sales of tech-company shares since 1999. "We're getting calls all the time from people who want to sell" at least part of their Uber stake, said Albukerk.
If Uber isn’t allowing its employees to sell their shares, as many allege, the potential imbalance between supply and demand could be even larger.
The example of Uber demonstrates how the illiquidity of private markets makes them much worse than public markets for communicating information about a company.
In a public market, the price is determined by a tug-of war between optimistic and pessimistic investors. People who are optimistic about a company’s long-term earnings potential -- -- will be willing to buy at higher prices. But pessimists either sell or short-sell the stock, driving its price down and giving the optimists a bargain. The short-sellers are at a bit of a disadvantage in this battle, since shorting is risky and expensive. But unless there are so many bulls that they run the bears completely out of the market, the tug-of-war usually remains reasonably balanced. That doesn’t mean public markets always get things right, just that the pessimists’ opinions do get incorporated into the price.
Private markets are different. You can’t easily short-sell a private stock, since there are very few people around to borrow shares from. (Short-sellers borrow shares and sell them on the open market, hoping to buy them back in the future at a lower price and pocket a profit.) And because of employer lock-ups, shareholders often can’t even sell at all. That means the price of the stock often gets determined by the most bullish investor. Saudi Arabia was willing to value Uber at $62.5 billion in June 2016, but how many others would have done the same? Uber was free to shop around until it found the investor who would pay the most for its shares, and its lofty valuation was a result of that search.
For many startups and smaller private companies, those headline valuations never fall until the company either goes public, goes out of business or is forced to raise a down round -- that is, taking in capital at a lower valuation. For a giant like Uber, there is a secondary market, but the difficulty of matching buyers and sellers means that it can often take quite some time for increased pessimism to be reflected in prices -- and even then, the prices paid will often be secret. So despite its troubles, Uber still gets to market itself as a company with a sky-high valuation for months or years, even if investors are taking a dimmer view of its prospects.
This demonstrates why it’s very dangerous to replace public markets with private ones as the driver of capitalism. In January, Bloomberg View’s Matt Levine wrote an excellent article about how private markets have gained in importance in the U.S. And my Bloomberg View colleague Barry Ritholtz reported back in 2015 about the disturbing decline in the number of publicly listed companies. If private markets replace public ones, the degree to which financial markets give us good information about companies’ real economic value will be substantially degraded. That would be bad news for the U.S. economy’s ability to allocate capital to the businesses best able to put it to good use.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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