Harsh Reality Of Tech Stocks: Not Everyone Can Be A Unicorn

As unsettling as it can be to watch the Dow shed more than 500 points in consecutive trading sessions, investors should relax, take a deep breath and put things in perspective – this was not a crash, nor are we on the brink of another financial crisis. Indeed, the recent losses may have contained a silver lining.

With much of the rest of the world confronting steep challenges in recent months and with bonds yields paltry, U.S. stocks were the one place investors could capture returns. Without much earnings growth to underpin the day-after-day increases, valuations were becoming unsustainable across multiple sectors. With the retreat, perhaps some sanity has returned to the markets, and many companies are now priced just about right.

In the technology sector, investors are always looking for the next big thing – firms that go public at a fair price, escalate in value over the course of many years and then, ultimately, go on to redefine the industry. We saw this progression with Apple and Microsoft many years ago, and then again more recently with Google and Facebook. But for every Apple and Google, there have been dozens of once-hot, can’t miss tech companies that have completely flamed out after their IPOs.

Consider the social gaming company Zynga. After Farmville quickly attracted 10 million users, Zynga became deeply embedded with Facebook’s platform and went public in 2011, raising around $1 billion. It hasn’t produced another hit since and its share price has plummeted nearly 75 percent.

There was also Groupon, a one-time hugely popular service that connects retailers and other business with consumers by offering steep discounts on goods and services. In the run up to its IPO, the popular narrative was that the company was poised to reshape the marketplace and redefine consumer behavior. It hasn’t worked out that way. Groupon is down more than 80 percent since.

And there are countless other examples as well, including Box , King Digital Media, and Lending Club . All were so-called unicorns that suddenly turned into frogs once they went public. With this in mind, who are the next batch of aspirational unicorns bound to disappoint as public companies?

Snapchat – The company’s recently leaked financials tell the story: It’s struggling and has no clear path toward achieving more growth and becoming profitable. It’s clear by now that Snapchat CEO Evan Spiegel should have considered Facebook’s reported $3 billion bid a couple years ago. But he didn’t. And whether it was greed, ego or naiveté, it doesn’t’ matter – he’s now in a tough spot. Not only have other services replicated Snapchat’s once-unique technology but his company still faces the same imposing hurdle that has always been its biggest obstacle: The platform is unattractive to advertisers. Complicating matters is that while it remains popular among teens, older, more coveted users spend most of their time on other social media sites, like Instagram and Facebook. Unless this changes, it’s tough to envision a scenario in which Snapchat remains relevant over the long term.

Airbnb – After its latest round of financing, Airbnb has a reported valuation of more than $25 billion. That means it’s worth more than Hilton. Nonsense. Airbnb at this point is basically an idea – one that is bound to fail. Forgetting for a moment that the company tears at the fabric of individual neighborhoods, its business is basically illegal. Hotels and other hospitality companies spend billions on taxes, zoning and other expenses. Airbnb doesn’t do any of this. We’ve already seen strong resistance to its model in areas across Southern California and New York City as well as many incidence of problems and criminal activity. If more and more cities and states start to push back – which seems likely – Airbnb cannot survive in its current form.

Uber – Unlike Snapchat and Airbnb, Uber is a good business. Its technology is disruptive and gives the market something it desperately wants – reliable, on-demand transportation at your fingertips. But it has expanded too rapidly, and this had led to a series of costly legal and regulatory battles in markets all over the world. In some countries, such as Brazil and France, Uber faces outright hostility, with drivers being involved in violent clashes with cab drivers. At some point, investors need to consider whether the money Uber has raised will go towards new growth or its ever-growing legal bills. There’s also the independent contractor issue to consider. A California district court is currently considering whether to re-classify Uber’s drivers as employees from independent contractors. If that happens, the company would be forced to pay millions in payroll taxes, overtime pay and other benefits, significantly slashing its earning potential. With a $51 bil valuation and $2 bil in revenue and no profits, Uber will have to drive everyone to justify its lofty valuation.

Each of the above companies are currently wildly popular, not to mention a darling of venture capitalists. But there’s a difference between being popular and long-term valuation and profits. We expect to see the VC’s exit by taking these companies public to cash out at these extreme valuations. Beware as these expectations seem bound to disappoint and with that same with their stock prices. When the two collide on the open market, true valuation always wins, just ask Zynga or Groupon or for that matter.

Ross Gerber is CEO and president of Santa Monica, Calif-based Gerber Kawasaki, an independent investment advisory and wealth management firm with approximately $385 million in assets under advisement. Clients and employees may own positions in various companies mentioned in the article.

By Ross Gerber

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.

Gerber Kawasaki, 2716 Ocean Park Blvd. #2022 Santa Monica, CA 90405. Contact us at (310) 441-9393.