Tuesday, July 14, 2009

Startup Valuations: Too much, too early?

Corporate valuations of the cleantech firms have always been an issue of fervent debate. On one hand, a set of market participants advocates usage of traditional valuation methods (discounted cash flow, comparable company analysis etc.) to arrive at a figure, while another school of thought propagates the consideration of intangible variables like the impact of new technology on common masses and the quantum change the technology promises to bring in daily life of an average user. Automotive battery and electric vehicle manufacturers are no exceptions with a number of low sales, concept stage companies receiving high valuations. Here are a few examples.

A123Systems Inc.
The company was incubated in MIT in 2001. After initial rounds of funding and dropping the original idea of self-organizing batteries, A123 scored big with a contract to supply batteries to Black & Decker power tools in 2005. The company has raised around US$300m in as much as six rounds of funding excluding the common shares placed early last year. GE has been the largest investor in the company and its US$70m investment till now accounts for a close to 10% equity stake in the company. Apart from GE, the company counts North Bridge Venture Partners, Motorola, Sequoia Capital, Qualcomm and Procter and Gamble among its investors.
As expected, the latest round of funding is more of a pre IPO placement rather than a VC funding. However, with 1,100 employees worldwide A123 is hardly a start-up anymore. The company has secured orders from GM, Chrysler and SAIC.
In its S-1 filing in August 2008, the company wanted to raise an additional US$175m through an IPO at an enterprise valuation of US$1bn. IPO plans were scrapped later due to the crunch in financial markets but the company is hopeful to launch the IPO sometime in 2010.

Luxury electric vehicle manufacturer Tesla Motors, incorporated in 2003 has received funding from PayPal co-founder Elon Musk, Google founders Sergey Brin & Larry Page, VantagePoint Venture Partners and Draper Fisher Jurvetson. To its credit, the company has sold 500 premier Roadsters till June 2009 and plans to launch a more affordable Model S sedan by 2011. On the flip side, the company doesn’t have a strong product line or technology barriers as far as batteries are concerned.
Tesla is riddled with some management failures in the past and is currently under litigation through its founder and former CEO Martin Eberhard regarding the ownership of the founder title. However, its poor track record at handling the investor money has not stopped Daimler from investing in the start-up. The German automaker acquired a 9% stake in Tesla by investing US$50m in May 2009. Going by the deal, valuation of Tesla works out at close to US$550m.
As if the US$550m price tag wasn’t enough, the company has been valued at an eye-popping US$1bn in a private equity marketplace on 16 June 2009. Though the service was only a simulation and didn’t reflect the real-life market situations and serious buyers in Tesla shares, the valuation still provides a rough estimate of private equity investors.

BYD is not exactly an early stage company with venture capital. It is also not an unproven and speculative business model, but being the only listed company among the pack makes the details more trustworthy.
In September 2008, at the time of the deal with Berkshire Hathaway, BYD was valued at US$2.3bn on the basis of US$230m investment for 10% stake. The market capitalisation of the company has now swelled to US$9.2bn.
The Warren Buffett company invested at a PE multiple of 12.3 which has now increased to 52.5. Given that a lot in the appreciation of the valuation of the company has to do with the Berkshire investment, strong performance by the company in recent months should not be ignored.
Corporate valuations have always been debatable but investments in the recent times are significant as they promise to change the course of mankind. Altruism apart, free markets have their own rationale of arriving at the valuations. But the exorbitantly high valuations in one of the most credit starved times in modern history have surely left the analysts wondering.


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Tarun Mitra said...

It was really surprising to find a finance blog in there blogosphere smeared by Life Stories and other Stuff.

I could agree with you more on this that start up valuation on green companies are getting far too stretched. But who knows whether they Deliver.

Berkshire has become a cult by now, wherever they invest, or even rumored to invest, the stock goes up. It happened with ONGC IPO few years earlier, where there was a rumor. For BYD, Buffet himself has said that the company is the largest LiOn battery manufacturer with thousands of engineers at its disposal. Secondly, the stimulus package by the Chinese govt. might have somthing to do with the valuation. It is estimated that within the next three years, Chinese markets will overtake that of US. So finding BYD PE at 52 can hardly be surprising.
When Tesla launched it roadster, the auto experts hammered Reva, its largest rival. But till now, its sales are less than that of Reva...finding that valuation was surprising.....

Anil said...

True, Tarun. Anything Buffett touches turns in gold. However, the fundamental question is about the valuation method of companies. As securities analysis puts it, future cash flows can be discounted to arrive at the fair present value. Now the problem boils down to the issue of the premium individuals and institutions are willing to put on the security.

This method works well for mature companies with well defined revenue stream. For startups, this method isn't necessarily the best where survivability of the company after 5 years is questionable.

Somehow, financial markets have the tendency of exaggerating the valuations and collapse in the long term...

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