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16/12/20194 mins

Peak Unicorn?

One evening in September 2007, whilst on holiday, a flickering TV caught my attention. I was stunned to see a report that concerns about the financial strength of Northern Rock had dramatically escalated. Rather than accept the reassurances of the authorities, people were queuing around the block to withdraw their money. Admittedly, I had been worried for some time about the debt-funded party that had characterised the previous few years of economic activity but, to me, this was a tangible sign that we had reached the peak of that cycle. I had no exact knowledge of what would happen next but I reasoned that anything that had come to depend on easy money was shortly going to be in difficulty.

As it turned out, money markets and credit conditions continued to deteriorate, which culminated, a year later, in the bankruptcy of Lehman Brothers. Looking back, there are two factors that I continue to find surprising. The first is how bad things got. I would not have predicted, in 2007, the de facto bankruptcy of the Western banking system within a year. The second is how the markets initially reacted to the downturn in the cycle. As credit markets froze and the US headed for recession, the markets’ ‘animal spirits’ decided that emerging markets could ‘decouple’ from developed markets. Further, as emerging markets required a lot of raw materials, the logic was extended such that commodity prices could also ‘decouple’. Accordingly, for about nine months ‘decoupling’ became the hottest investment theme, culminating most memorably in the oil price hitting a high of around $146 per barrel in July 2008. By the end of that year, as economic activity ground to a halt, the oil price was close to $40 which showed that decoupling was always a fanciful notion. Nevertheless, had investors correctly predicted the outcome of these events and acted accordingly in September 2007, they still would have endured a very uncomfortable nine months before their investment decisions came good.

I mention this because it seems that the recently failed IPO of WeWork is a similarly significant event for the ‘unicorn’ party and, perhaps, loss making ventures in general. A unicorn is the term given to private, recently started businesses that have an implied valuation of over $1bn. WeWork was one of the biggest unicorns of all, with an implied valuation of $47bn (for context, a well known company of similar market capitalisation is BMW). Many unicorns present themselves as technology based disrupters but actually operate at vast losses in low margin, cyclical industries with revenue growth only sustained through a subsidised user experience. In effect, these companies require a constant supply of new capital to sustain their business models.

I cannot say with certainty what the ramifications will be of the bursting of this ‘disruption’ bubble but, as I have expressed before, my view is that this particular investment theme has been one of the more egregious by-products of a cheap money environment. I think, if the mood is starting to turn away from these sorts of investments, that the unloved but cheap areas of the market will find favour.

Alasdair McKinnon

16 December 2019

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