How to hunt down a unicorn

By Justin Hall January 22, 2016

Macro-economic forces will change the unicorn-investor game this year
Its competitors don’t need to beat Uber, they only need to outlast it

How to hunt down a unicorn THE reports of the death of the startup unicorn seem to be greatly exaggerated.

In spite of a seemingly endless stream of pessimistic declarations and mournful announcements, it would seem that the number of unicorns has only increased.

In September 2015 – just four months ago, mind you – there were roughly 100 unicorns. To date, that number has increased to 229 unicorns, or US$229 billion of funding and an aggregate private value of US$1.3 trillion.

And there’s no bigger poster boy for startup unicorns than Uber.

Expectations are that Uber will soon return to the market, hat in hand, to raise an additional US$2.1 billion, effectively valuing the company at roughly US$65 billion. More importantly, that brings the total amount of funding Uber has raised to about US$10 billion.

And what number are they using to justify that valuation? Purported bookings of US$10 billion in 2015. Phew.

And given that Uber takes about 20% in booking fees, that’s about US$2 billion in gross revenue. That’s significant, and goes a long way in helping to justify that massive price-tag.

But Uber loses money, too. Lots and lots and lots of money.

Leaked figures show that, over an undisclosed time period, Uber generated US$415 million in revenue against operating costs of US$470 million. That’s a US$55-million loss on what is likely several billion dollars in gross transactions.

So what is Uber actually spending all that cash on? (A better question would have been: What isn’t it spending cash on?)

In short: Market expansion, especially in China and India (indeed, China warranted the creation of a new company, Uber China); research and development, like self-driving cars and logistics; the execution of various new products and services; and last but not least, acquisition.

Lots and lots and lots of acquisitions, through marketing, driver bonuses, and ride subsidies.

So Uber dumps a lot of cash, It subsidises rides for passengers and offers huge signing bonuses for new drivers in order to build up both sides of its marketplace.

And breaking into new markets and maintaining market share in others is not an inexpensive endeavour. This is especially true in places such as China and, to a lesser extent, South-East Asia and India.

Why?

Because Uber is locked in an existential, bloody boxing match with its competitors.

There’s Didi Kuaidi in China, Ola in India, Lyft in the United States, and GrabTaxi in South-East Asia.

This shouldn’t come as a surprise. Most industries have numerous competitors vying for market share and customers. Transportation is no different.

Except, of course, for the fact that each of these competitors would be considered disruptive in their own right; each of these competitors is funded to the tune of several billion dollars; and each of these competitors is respectively setting its crosshairs on Uber.

You have Tencent’s WeChat shutting down access to Uber in China; local players leveraging their homegrown connections to reduce Uber’s competitiveness; and, perhaps most significantly, the Big Four Transportation companies have publicly allied: Starting next year, they will allow users to book cabs from each other’s apps in all the regions where they operate.

And yet, Uber is still winning. Uber is still a clear market leader in numerous markets, including the all-important United States (with the exception being Didi Kuaidi, which holds a clear lead in China).

And Uber is likely to successfully close its new round of funding, further solidifying its leading position in the market.

But those companies don’t need to beat Uber. They only need to outlast it.

Yes, a partnership between Uber competitors is significant. Yes, having friends in government throw roadblocks on Uber is certainly useful. Yes, disrupting Uber’s ability to reach its customers is advantageous.

But inflating those initiatives as existential threats to the company are overwrought: They can hurt Uber, but they can’t kill it.

What these initiatives are successful in doing is to keep Uber on the defensive, where it must continue raising money to keep it competitive and maintain market share.

Like a boxer in a ring, Uber will continue to overpower its opponents so long as it is able to retreat to its corner, take a breather, and raise a new round of funding.

And therein lies the problem: In 2016, more investors will begin throwing in the towel.

Global market volatility, commodity prices, rising US interest rates – all this means that the risk appetite is shrinking. And as the risk appetite declines, the propensity for investors to continue supporting multibillion-dollar funding rounds at sky-high valuations will understandably wane.

In short, unicorns are turning into unicorpses.

Uber has become a US$70-billion company almost entirely due to the fact it is a market leader in so many cities and countries. But it was able to achieve that due to the nearly US$9 billion in funding.

That’s US$9 billion worth of subsidies, acquisition costs, research and development, and legal and administrative fees.

What happens when it no longer has the money to do those things?

More importantly, what happens if its competitors still do?

Uber is nothing if not smart: It could easily have a significant war-chest saved up, a war-chest that could very well sustain operations while it painfully transitions away from the old, cash-burning model to one that is leaner, more profit-generating, and sustainable.

It has also made significant headway into complementary business models that could easily validate its valuation – and pave the way for an IPO (initial public offering) – if successful: Self-driving cars would entirely remove the need for fickle, expensive-to-acquire drivers; and Uber has publicly declared its intention to create a computerised logistics network, essentially the world’s largest, most efficient logistics fleet.

But what is clear is that this match is only going to get bloodier as funding opportunities become smaller and more infrequent.

Uber’s meteoric valuation make its competitors look like veritable bargains to private investors; the opportunities for additional funding could easily dry up for it before it does Didi Kuaidi and Lyft, and as Uber’s cash-burn declines, its competitors – and their investors – could see an opportunity to pick up the pieces.

So 2016 could be the start of a curious, ironic reversal: Uber finding itself financially outmatched by its competitors, struggling to find the cash to maintain market share and grow its operations.

This year we might just finally see this match come to a head. And while Uber might have every desire of finally jumping out of the ring, its competitors will work to make it do precisely the opposite.

Justin Hall is a principal at Golden Gate Ventures, an early-stage fund based in Singapore. You can reach him via Twitter at @JVinnyHall. This article first appeared on his blog and is reprinted here with his kind permission.

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