Aswath Damodaran, Uber’s Valuation and Ratchets

The last time I’d written about Aswath Damodaran’s comments on Uber’s valuation, it was regarding his “fight” with Uber investor Bill Gurley, and whether his valuation was actually newsworthy.

Now, his latest valuation of Uber, which he concludes is worth about USD 28 Billion, has once again caught the attention of mainstream media, with Mint writing an editorial about it (Disclosure: I write regularly for Mint).

I continue to maintain that Damodaran’s latest valuation is also an academic exercise, and the first rule of valuation is that “valuation is always wrong”, and that we should ignore it.

However, in the context of my recent piece on investor protection clauses in venture investments (mainly ratchets), it is useful to look at Damodaran’s valuation of Uber, and how it compares to Uber’s valuation if we were to account for investor protection clauses.

“True value” of Indian unicorns after accounting for investor protection. Source: Mint

When Uber raised $3.5 Billion from Saudi Arabia’s Public Investment Fund earlier this year, the headline valuation number was $62.5 Billion. Given the late stage of investment, it is unlikely that the investor would have done so without sufficient downside protection – at the very least, they would want a “full ratchet” (if the next investment happens at a lower valuation, then they get additional shares to compensate for their loss). This is a conservative assumption since late stage (“pre-IPO”) investments usually have clauses more friendly to the investor, usually incorporating a minimum “guaranteed return”.

Plugging these numbers into the model I’ve built (pre-money valuation of $59 Billion and post-money valuation of $62.5 billion), the valuation of the put option written by existing investors in favour of Uber comes to around $1.28 Billion. Accounting for this option, the total value of the company comes out to $39.6 Billion.

Damodaran’s valuation, based on his views, principles and numbers, is $28 Billion. Assuming that investors and management of Uber are aware of the downside protection clauses and its impact on the company’s valuation, Damodaran’s valuation is not that much of a discount on Uber’s true valuation!

Offshoring and the daNDapiNDagaLu moment

Sometime in the early 2000s (2000 or 2001, if I’m not mistaken), there came a sitcom on Kannada television (Udaya TV, if I remember correctly) called “daNDapiNDagaLu” (no direct translation to English available, but it translates to something like “waste bodies”).

The sitcom was about the travails of five boys who had studied one of {B.A., B.Sc., B.Com. } and were subsequently unemployed. Directed by Phani Ramachandra, of the Ganeshana Madhuve and Gowri Ganesha fame, it was rather funny and mostly well received. The most memorable part of the sitcom, however, was the iconic title song (the version on Youtube is audio-only, but that will suffice for our purposes).

For non-Kannada speakers here, the song is about people who study B.A., B.Sc. or B.Com. and subsequently fail to find a job, and then roam the streets with little to do. The song also talks about the unwillingness of these people to do menial jobs, of not being of the “right caste” to avail reservations, and not having the ability to get good marks which can get them a job.

Thinking about it, the song was extremely appropriate for its times, and the release of the serial coincided with the low point of the value of a B.A., B.Sc. or B.Com. degrees in India (I remember feeling rather proud when the sitcom came out that I was studying engineering, and hence wasn’t one of “them”).

Until the 1980s or so, the possession of a bachelor’s degree qualified you for a large gamut of opportunities, mostly in the government. So it didn’t matter that much what you studied, and if you weren’t particularly useless, you’d find a job to get by on.

To take an example, my mother had a bachelor’s in biology, but spent most of her career in an accounting job (she entered the workforce in the 1970s). In other words, it didn’t matter what degree you had, as long as you had one. So people gladly did whatever degree they could get into.

In the 1990s, however, with the government sector on the decline and liberalisation not having had enough of an impact to massively expand the job market, there was trouble for these graduates. Government was no longer recruiting as it used to, and the private sector wasn’t picking up the slack either. It was at this time that most such graduates started going jobless, and the value of these degrees diminished like crazy.

It is no surprise that around the time I finished high school (2000), everyone wanted to study engineering – opportunities for most other degrees were very few. With liberalisation in the education sector having kicked in, supply in engineering college seats expanded to meet the demand (in some states at least). It was a popular meme in those days that anyone who studied for a B.A. or a B.Sc. did so only because they couldn’t get an engineering seat.

It was around this time, the absolute low point for B.A., B.Sc. and B.Com. that daNDapiNDagaLu came out. The sitcom lost its relevance rather soon, though.

With liberalisation in full swing in India,development in communications technology, and slowing growth in developed markets, “offshoring” became a thing. Companies in developed western markets figured out that they could get routine stuff done for a lot cheaper by “offshoring” them to emerging markets, where labour was a lot cheaper.

And some of those jobs came to India, which had a large pool of (hitherto unemployed) graduates, most of whom spoke English. It started with call centre jobs (where Indians were trained to get Western or “neutral” accents, and Janardhans became Johns). Then came slightly higher value adding jobs, like accounting, secretarial services, etc. Business Process Outsourcing was soon a thing, and it didn’t take Thomas Friedman too long to write The World is Flat.

With the coming of these jobs, the market for people with B.A., B.Sc. and B.Com. was suddenly opened up, and there was a range of jobs these people could do. Today, someone with one of these degrees, as long as they are reasonably capable, can expect to find a job after graduation.

Society hasn’t kept up, though. A lot of people are still in the daNDapiNDagaLu mode, and consider those studying B.A., B.Sc. or B.Com. as potential “waste bodies”, not realising that the time now is different!

Regulating HFT in India

The Securities and Exchange Board of India (SEBI) has set a cat among the HFT (High Frequency Trading) pigeons by proposing seven measures to curb the impact of HFT and improve “real liquidity” in the stock markets.

The big problem with HFT is that algorithms tend to cancel lots of orders – there might be a signal to place an order, and even before the market has digested that order, the order might get cancelled. This results in an illusion of liquidity, while the constant placing and removal of liquidity fucks with the minds of the other algorithms and market participants.

There has been a fair amount of research worldwide, and SEBI seems to have drawn from all of them to propose as many as seven measures – a minimum resting time between HFT orders, matching orders through frequent batch auctions rather than through the order book, introducing random delays (IEX style) for orders, randomising the order queue periodically, capping order-to-trade ratio, creating separate queues for orders from co-located servers (used by HFT algorithms) and review provision of the tick-by-tick data feed.

While the proposal seems sound and well researched (in fact, too well researched, picking up just about any proposal to regulate stock markets), the problem is that there are so many proposals, which are all pairwise mutually incompatible.

As the inimitable Matt Levine commented,

If you run batch auctions and introduce random delays and reshuffle the queue constantly, you are basically replacing your matching engine with a randomizer. You might as well just hold a lottery for who gets which stocks, instead of a market.

My opinion this is that SEBI shouldn’t mandate how each exchange should match its orders. Instead, SEBI should simply enable individual exchanges to regulate the markets in a way they see fit. So in my opinion, it is possible that all the above proposals go through (though I’m personally uncomfortable with some of them such as queue randomisation), but rather than mandating exchanges pick all of them, SEBI simply allows them to use zero or more of them.

This way, different stock exchanges in India can pick and choose their favoured form of regulation, and the market (and market participants) can decide which form of regulation they prefer. So you might have the Bombay Stock Exchange (BSE) going with order randomisation, while the National Stock Exchange (NSE) might use batch auctions. And individual participants might migrate to the platform of their choice.

The problem with this, of course, is that there are only two stock exchanges of note in India, and it is unclear if the depth in the Indian equities market will permit too many more. This might lead to limited competition between bad methods (the worst case scenario), leading to horrible market inefficiencies and the scaremongers’ pet threat of trading shifting to exchanges in Singapore or Dubai actually coming true!

The other problem with different exchanges having different mechanisms is that large institutions and banks might find it difficult to build systems that can trade accurately on all exchanges, and arbitrage opportunities across exchanges might exist for longer than they do now, leading to market inefficiency.

Then again, it’s interesting to see how a “let exchanges do what they want” approach might work. In the United States, there is a new exchange called the Intercontinental Exchange (IEX) that places “speed bumps” over incoming orders, thus reducing the advantage of HFTs. IEX started only recently, after major objections from incumbents who alleged they were making markets less fair.

With IEX having started, however, other exchanges are responding in their own ways to make the markets “fairer” to investors. NASDAQ, which had vehemently opposed IEX’s application, has now filed a proposal to reward orders by investors who wait for at least once second before cancelling them.

Surely, large institutions won’t like it if this proposal goes through, but this gives you a flavour of what competition can do! We’ll have to wait and see what SEBI does now.

Callousness of the callus

When my wife went to the University of Michigan as an exchange student, she embarked on a “social experiment” that I later termed “Lord of the ringless” (I’m not sure if I’ve mentioned here already  that she’s a big fan of social experiments).

The hypothesis, based on advice from a senior in her own college, was that a married exchange student was unlikely to win too many friends, and find too many people to hang out with. With a number of potentially interesting conversations and friendships at her “home school” IESE having ground to a halt the moment the counterparty noticed the ring on her finger, she decided to leave her ring behind at home when she travelled to Ann Arbor.

The social experiment worked, for a while at least. She managed to find herself a solid assignment group, and a bunch of friends to hang out with, before she got “outed“.

Back home in Bangalore last December, she wore back her ring, and promised she would never take it off again. Simultaneously, she made me promise that I would never take off my wedding ring, either. I accepted conditionally. “Most of the time I’ll wear the ring”, I said, “but I need to take it off when I’m deadlifting. Else it will give me calluses”.

“Oh, but I love picking your calluses! Don’t deny me that opportunity!”, she shot back.

I may not have mentioned on this blog that she’s always been a big fan of picking out scabs and calluses, right from the time she was a kid. For a long time, this was restricted to picking out her own, but then once she found me, she has ensured that no scab or callus of mine has gone unattended.

And so, thanks to this arrangement, I continue to wear my ring while lifting, and that gives a big callus at the base of my right ring finger. And my wife enjoys picking out these calluses, and now she has her own incentive to make sure I remain fit and go to the gym regularly!

Though I’m considering buying a pair of weightlifting gloves now!

The problem with venture capital investments 

Recently I read this book called Chaos Monkeys which is about a former Goldman Sachs guy who first worked for a startup, then started up himself, sold his startup and worked for Facebook for a number of years. 

It’s a fast racy read (I finished the 500 page book in a week) full of gossip, though now I remember little of the gossip. The book is also peppered with facts and wisdom about the venture capital and startup industries and that’s what this blogpost is about. 

One of the interesting points mentioned in the book is that venture capitalists do not churn their money. So for example if they’ve raised a round of money, some of which they’ve invested, liquidating some of the investment doesn’t mean that they’ll redeploy these funds.

While the reason for this lack of churn is not known, one of the consequences is that the internal rate of return (IRR) of the investment doesn’t matter as much as the absolute returns they make on the investment during the course of the round. So they’d rather let an investment return them 50x in 8 years (IRR of 63%) rather than cash it one year in for a 10x return (IRR of 900%). 

Some of this non churn is driven by lack of opportunities for further investment (it’s an illiquid market) and also because of venture capitalists’ views on the optimal period of investment (roughly matching the tenure of the rounds). 

This got me thinking about why venture capitalists raise money in rounds, rather than allowing investors continuous entry and exit like hedge funds do. And the answer again is quite simple – it is rather straightforward for a hedge fund to mark their investments to market on a regular basis. Most hedge fund investment happens in instruments where price discovery happens at least once in a few days, which allows this mark to market. 

Venture capital investments however are in instruments that trade much more rarely – like once every few months if the investor is lucky. Also, there are different “series” of preferred stock, which makes the market further less liquid. And this makes it impossible for them to mark to market even once a month, or once a quarter. Hence continuous investment and redemption is not an option! Hence they raise and deploy their capital in rounds. 

So, coming back, venture capitalists like to invest for a duration similar to that of the fund they’ve raised, and they don’t churn their money, and so their preferences in terms of investment should be looked at from this angle. 

They want to invest in companies that have a great chance of producing a spectacular return in the time period that runs parallel to their round. This means long term growth wise steady businesses are out of the picture. As are small opportunities which may return great returns over a short period of time.

And with most venture capitalists raising money for similar tenures (it not, that market fragments and becomes illiquid), and with tenure of round dictating investment philosophy, is there any surprise that all venture capitalists think alike? 

Bloggers and anti-bloggers

I know this post “dates” me as someone who started blogging back in the peak era of blogging in the mid 2000s. But what the hell! 

I think you can consider yourself to have “made it” as a blogger when a post that you write attracts abuse. Sometimes this abuse could be in public, in the comments section of the blog. At other times, the abuse is in private, when someone meets you or calls you, and abuses you for writing what you wrote.

As long as you’ve been reasonable in your blogging (which the early years of this blog’s predecessor cannot exactly claim), abuse on your comments section is more of an indicator of the thin-skinnedness of the abuser, rather than you crossing lines on what you should write about.

At this point in time, it is pertinent to introduce the class of people who I call as “anti-bloggers”. Sometimes they might themselves have a blog, but that is not necessary, what is necessary is that they have a “holier than thou” attitude.

Anti-bloggers are people with especially thin skins who are always on the lookout for something to outrage about, and blogs, which allow people to express themselves freely on a public forum without editorial oversight, are a common whipping boy.

This outrage could come in several forms. The thicker-skinned version of this outrage happens from people who abuse you only if they think you’ve abused them on the blog (good bloggers take care to never mention names in a negative manner, so this is usually a case of “kumbLkai kaLLa heglmuTT nODkonDa” (the pumpkin thief looked at his shoulder; it’s a Kannada proverb meaning something like “every thief has a straw in his beard) ).

The thinner skinned version of anti-bloggers find it even easier to find things to outrage about. Look at the Bangalore post I’d written ten years back. There was no hint that I’d written about anyone at all, but the post received heaps of abuse, from people who manufactured some kind of entity that the post purportedly offended!

The most annoying anti-bloggers are those that abuse you when you simply pen down an observation that is there for all to see. I won’t take specific examples now, but sometimes the simple act of reporting a fact that is evident to everyone can offend people, for its existence on paper (a website, rather) gives it new-found legitimacy!

This last bit can also help explain the annoyance of some sections of the “mainstream media” with “social media” such as blogs/twitter. The worthies in the mainstream media had established certain unwritten rules by which certain facts/events wouldn’t be put down on paper.

The mention of these events in social media (which is unedited) suddenly gave these events/happenings sudden legitimacy, which steered the overall narrative away from where it existed during the mainstream media monopoly, annoying the mainstream media!

One penultimate point – anti-bloggers are the same people who talk about the glories of the days prior to social media (this piece in The Guardian is an especially strong specimen), when people could only read news that was filtered and possibly censored by newspaper editors.

And finally, ever since my credentials as a blogger were established about a decade back, some people have started explicitly mentioning to me when they are saying something “off the record”. And I’ve always respected these conditions!

Sweetshop optimisation on festival days

As I mentioned in my earlier post, while Varamahalakshmi Vrata is considered rather minor in my family, it is a rather big deal in my wife’s house. So I headed to a nearby sweetshop called Mane hOLige to fetch sweets for today’s lunch.

Now, this is not a generic sweetshop. As the name suggests, the shop specialises in making hOLige, also known as obbaTT, which is a kind of sweet stuffed flatbread popular in Karnataka and surrounding areas. And as the menu above suggests, this shop makes hOLige (I’ll use that word since the shop uses it, though I’m normally use to calling it “obbaTT”).

I had been to the shop last Sunday to pick up hOLige for a family gettogether, and since I asked for the rather esoteric “50-50 hOLige”, I had to wait for about 30 minutes before it was freshly made and handed over (Sunday also happened to be yet another minor festival called “naagar panchami”).

Perhaps learning from that experience, when heightened demands led to long wait times for customers, the sweetshop decided to modify its operations a little bit today, which I’m impressed enough to blog about.

Now, as the subtitle on the board above says, the shop specialises in “hot live hOLige”. They are presumably not taking VC funding, else I’d imagine they’d call it “on demand hOLige”. You place an order, and the hOLige is made “to order” and then handed to you (either in a paper plate or in an aluminium foil bag, if you’re taking it away). There is one large griddle on which the hOliges are panfried, and I presume the capacity of that griddle has been determined by keeping in mind the average “live” demand.

On a day like Sunday (naagar panchami), though, their calculations all went awry, in the wake of high demand. A serious backlog built up, leading to a crowded shopfront and irate customers (their normal rate of sale doesn’t warrant the setting up of a formal queue). With a bigger festival on today (as I mentioned earlier, Varamahalakshmi Vrata is big enough to be a school holiday. Naagar panchami doesn’t even merit that), the supply chain would get even more messed up if they had not changed their operations for the day.

So, for starters, they decided to cut variety. Rather than offer the 20 different kinds of hOLige they normally offer, they decided to react to the higher demand by restricting choice to two varieties (coconut and dal, the the most popular, and “normal” varieties of hOLige). This meant that demand for each variety got aggregated, and reduced volatility, which meant that…

They could maintain inventory. In the wake of the festival, and consequent high demand, today, they dispensed with the “hot, live” part of their description, and started making the hOLiges to stock (they basically figured out that availability and quick turnaround time were more important than the ‘live’ part today).

And the way they managed the stock was also intelligent. As I had mentioned earlier, some customers prefer to eat the hOLige on the footpath in front of the store, while others (a large majority) prefer to take it away. The store basically decided that it was important to serve fresh hot hOLige to those that were consuming it right there, but there was no such compulsion for the takeaway – after all the hOLige would cool down by the time the latter customers went home.

And so, as I handed over my token and waited (there was still a small wait), I saw people who had asked for hOLige on a plate getting it straight off the griddle. Mine was put into two aluminium foil bags somewhere in the back of the store – presumably stock they’d made earlier that morning.

Rather simple stuff overall, I know, but I’m impressed enough with the ops for it to merit mention on this blog!

Oh, and the hOLige was excellent today, as usual I must say! (my personal favourite there is 50-50 hOLige, if you want to know)