Wednesday, June 11, 2014

Following The Smart Money Isn’t Smart: Uber

Following The Smart Money Isn’t Smart: Uber

If there’s one thing I’ve learned as an investor, it is to avoid following the “smart money.”  In a recent column, Andrew Ross Sorkin, editor of Dealbook, tries to justify the recent valuation placed on Uber.[1]  Uber is the company that has built the software and network to provide an alternative form of transportation to taxis and limousines.  The latest round of financing values Uber at $18 billion.  Mr. Sorkin spends most of his column trying to come up with a set of assumptions to justify the most recent valuation of the company.  This part of Mr. Sorkin’s column is a useful exercise because it forces his readers to think about just how crazy or reasonable the market is for private tech companies.  While I think the assumptions tend more toward crazy than reasonable, I have to admit there’s some chance that Uber’s platform could some day become a huge company.

In the second part of his column, Mr. Sorkin commits a serious violation of sound investing when he asserts:

If you’re still scratching your head about Uber’s valuation, consider the “smart money” that plowed $1.2 billion into the company before its recent valuation, only 10 months after it was valued at only $3.5 billion: Fidelity Investments, BlackRock, Kleiner Perkins Caufield & Byers, Google Ventures, Menlo Ventures and Wellington Management and Summit Partners.

Following the “smart money” is a terrible way to invest.   Rather than doing your own homework, you are simply assuming that a so-called smart investor has made a sound decision in this particular case.  While the smart money may have a good batting average, they also strike out quite frequently, especially in venture capital.    In addition, you have no way of knowing their motivation or the amount of risk they took by making an investment.  Rather than seeking a huge profit, some of the “smart money” might be looking for ancillary business benefits from doing the deal.  Other smart money might be trying to cultivate a relationship in order to participate in another deal some time in the future.  Most of the smart money has probably made a tiny bet relative to its own net worth.  In other words, you really don’t know what, if anything, the smart money knows about a particular investment. 

When I was CIO at North Carolina I never wanted to know who else was invested in a fund until after we’d done all our due diligence and reached an investment conclusion.  It is just too tempting to cut short the hard work of analyzing an investment when you can just take a peek and see if Yale, Harvard, or some other smart investor has already made a commitment.

There’s one more problem with Mr. Sorkin’s reliance on the all-star investors who have made a bet on Uber.  The institutions cited by Mr. Sorkin made their bet when the price to participate was $1.2 billion.  You have to wonder whether they’d be willing to play today at 15 times that price.  Perhaps the smart investor would be wise to pass on investing at Uber’s current valuation.


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