In VC, No One Can Hear You Scream
Investors are shifting their gaze downward from top-line revenue to the apex predator of VC dreams: free cash flow.
In the past two days investors have gotten three data points that should cause serious concern:
- The WeWork IPO getting revalued to $15-$20 billion (or cancelled), when their last raise was done at a $48 billion valuation;
- Ford being downgraded to junk status, and;
- Consumer Credit growth unexpectedly doubling.
The bizzaro world of private unicorns (privately held firms with $1 billion and higher valuations) has now officially begun to crash. Of course, we've seen this movie before, it was called the tech wreck.
Back then the companies were public, and your grandmother owned them. In the sequel, only the "smart" money has been able to get in on the deal. However, as so often happens, the smart money is just as dumb as retail, only with more zeros behind their investments.
The WeWork valuation declining by 50-70 percent overnight is good indicator of the speculative appetite of investors. The liquidity spigot is being turned off just when the exponential revenue growth of these unprofitable firms requires ever bigger rounds of additional funding.
I predict a unicorn slaughter as investors shift their gaze downward from top-line revenue to the apex predator of VC dreams: free cash flow.
Ford's long-term corporate family rating was just downgraded to Ba1 from Baa3 by Moody's.
This should come as no surprise, the firm has been a money loser for years and its debt has exploded while its current ratio has fallen to two.
The knock on effects could be more serious. Many large institutional investors are prohibited from owning junk bonds. Thus they will have to sell their Ford paper. Who will buy it? Junk bond funds, of course. But where will they get the money? Likely by selling their worst quality paper. (If credit is being restricted for Ford, how bad will it get for the marginal firms barely holding on?)
Who will buy the really toxic paper being sold? Maybe no one. Or maybe just the vultures at cents on the dollar. In any event, the liquidity spigot gets turned off or becomes a lot more expensive for junk bond issuers.
Pro tip: this ends a lot of the stock buybacks that have been the last buyer of equities.
Chart 1: Ford Net Income
Chart 2: Ford Total Debt and Current Ratio
Consumers are tapped out and trying to keep it going with the last source of liquidity they have, credit cards. This happened in the lead up to the Global Financial Crisis as well. Of course, this is the most expensive form of finance known to man.
While interest rates are at 5,000 year lows for government issuers all across the globe, U.S. consumers are paying 17+ percent on their credit cards.
Remember, debt is just future consumption used in the current period. This will not end well for the U.S. economy. (Credit cards being maxed out in August do not result in good sales in December.)
Finally, credit card charge offs have been increasing since 2016. That spigot will be closing soon as lenders try to get ahead of defaulting borrowers.
Chart 3: Consumer Credit Net Change
Chart 3: Credit Card Charge Off Rate
Liquidity is, or will be, cut off from speculative startups, money-losing old economy firms, and the U.S. consumer. This is classic late-cycle behavior.
Investors should be shifting to a defensive posture in all areas of their portfolios.