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John Mauldin: Mutual Funds Could Pop The Silicon Valley Bubble
Superficial article as typical of financial writers that mixes facts with fantasy. Unicorns are under threat but nothing to do with mutual funds or their valuation practices.
1. Mutual funds amongst money from Russian "mobs" and Chinese transfers made Unicorns possible.
The late stage funding arrangements have very little to do with valuations but rather the terms of the funding.
2. The mark-to-market that mutual funds have done have very little correlation with the valuation of companies which is determined by the next funding event or IPO. Because each funding round has its own terms including liquidation preferences, a new round can come in at an even higher valuation than before if the terms are right. This may lead to earlier round investors having to take a write-off on their investments to mark to market as they go down the pecking order of preferences or get diluted with new shares issued.
3. Unicorns are facing potential down rounds recently but this has nothing to do with mutual funds investing in them. It is all about the exit potential with IPOs becoming dimmer and the perception that the era of free money with increasing rates is coming to an end to raise even more funds.
If Theranos, the $9B unicorn health care darling of Silicon Valley (and the media darling because of the photogenic founder) which has over-promised and under-delivered, falls down in its own hubris, it will bring down many unicorns more than anything else. It has no mutual fund investors.
Thanks for that honor @Ted while I note that it would have been far more rewarding to be in one of those unicorns with even half an exit than be an expert on it from the outside.
No expert on Uni's or Theranos. Never heard of Theranos until reading above. Google search reveals some no no's found recently at Theranos' lab by U.S. health inspectors.
I've been following Theranos for awhile now, as its technology has the opportunity to be uniquely disruptive to the delivery of healthcare services both inside a hospital/clinic environment and outside as well.
The technology does have a 'black-box" quality to it, as it hasn't gone through routine peer review testing, but is relying instead on the FDA for this verification. This has a local flavor for me, as the Cleveland Clinic stepped forward to establish a partnership with Theranos, with the Clinic doing this testing and verification external to the FDA.
If this turns out to truly be a viable technology and the company goes public, it may be the most anticipated IPO in years.
Lot of moving parts to the Theranos story which is evolving continually.
Walgreens has stopped its expansion plan pending further data/clarification. Safeway deal fell through as Safeway walked away.
Cleveland Clinic has distanced itself stating that it has not tried or evaluated the methodology or the product.
CEO promised to release the results of studies after the first WSJ article but has not done so.
The Board keeps changing its composition and has had some influential people but questionable choices. The Stanford professor who was initially on the advisory board and gave it credibility has quit the board. The lead scientist killed himself many years ago and his wife has claimed that he was ranting "Nothing is working at Theranos".
There is no management team except the founder CEO and a COO who is considered a sycophant and of dubious ethics. Has been accused of asking employees to use only the comventional machines for results submitted for FDA approval based on some emails.
Most of the tests are currently being done either using conventional equipment from Siemens etc or outsourced to third party facilities paying many multiples of what they are charging their customers, in other words burning VC money.
The star VC in its lineup DFJ is trying to distance itself stating that it only provided the initial seed money and did not participate further. Crunchbase states otherwise. A VC in Google Ventures came out to say why it didn't invest in Theranos and Theranos shot back it rejected them.
It is a very complex situation even in Silicon Valley which is used to a lot of hype and not at all black and white brilliant/fraud/scam clarity outside world wants.
My perspective without any private or inside knowledge about this secretive company but with having been in the startup grind through good and bad times:
It is a story SV badly wants to be a success for everyone's sake but privately afraid that it might become a black eye.
It has all the characteristics SV wanted, a female Steve Jobs, a disruptive technology company that had real value to society unlike Snapchats and such, fight against established and dominant industry, etc, etc. It can be very lucrative for the area with a successful IPO which would prop up other unicorns.
It did a lot of things startups fail to do and so fail even with a good product. It marketed itself well. Did the right outward facing development in anticipation. Realizing that like Uber, the biggest hurdle would be regulatory in nature, stocked up on high powered individuals on its board which at one time included Henry Kissinger. Knowing that the defense industry could very well be the biggest and most lucrative customer for this product, got people with military and government connections into its board. It raised enough money so that it would have a long runway.
It struck a partnership with Cleveland Clinic to gain credibility and got a marquee customer Walgreens. The media adored the Founder CEO.
Everything was going great, except the product itself...
The founder Holmes seems to be one of those rare individuals (have never met her myself) that are able to talk otherwise reasonable people into doing or believing what she says. People say that it is because she is a young and pretty woman. It goes much beyond that because I have seen similar power in a few people (even worked with one of them) that weren't women or pretty. It is the same charismatic hold cult leaders have where followers suspend disbelief. But even industry leaders fall for this. The reality distortion field that people attribute to Steve Jobs has components of that. When I saw this firsthand with the person I worked with, I just couldn't believe it. At first I thought it was some kind of hypnotic trance or some kind of blackmailing when this person got fairly influential people to do amazing things for the company where they didn't have to do anything. Most successful CEOs have some of this but not always at that level.
Having been in the ups and downs of startup cycles, I am not going to claim this to be a fraud scheme even with things falling apart as I have listed above. Startups are like baseball teams with bandwagon fans. When things are going great, everyone wants to be associated with you. When thiñgs aren't so great, they won't return phone calls or invite you to come to their hospitality suites in ball games as they used to and some will even start to badmouth. It is all part of the game.
What I suspect happened is that the promise and potential even within the CEO's mind quickly outdistanced the product development. It happens. When Elon Musk started Tesla he was very naive about what is needed to build a production car but was in love with the promise and potential of the technology. Had to face the realities very soon and went through a similar phase, throwing the initial founder out, being accused of running a scam, etc. But the product eventually caught up sufficiently to survive.
It is a bit more extreme in the case of Theranos because the persuasive powers of the founder seems to have started the hype/promise rolling faster than I suspect even she anticipated. Because lining up these things typically take a long time you don't want to wait until the product is completely ready, except she may not have realized her own powers to get things moving.
It is like the scene in IronMan when Robert Downey Jr, discovers the power of the propelled suit and bounces around without much control but enjoying that power nevertheless. And once you have that ball rolling, you don't want it to stop. Just hope that the product catches up. It had all the ingredients of a market waiting for you with fame and fortunes and all you had to do was carry the ball past the goal posts.
It is my suspicion that the product development ran into serious problems in not being able to deliver on the initial promise for all the tests they wanted to do. It is not clear whether they were simply unable to do the tests or whether the test results were not reliable enough to commercialize. Whatever it is, the CEO had very little choice at that point other than to buy time hoping the product would catch up so they started to use conventional machines and outsourcing tests losing money and being extremely secretive about it.
People may fault her for it but this is what happens in Biotech all the time even with many of the public companies, people here may have in their portfolios knowingly or not.
The best case scenario is that the the original nano product of testing with a pin prick improves enough to become a reality like a fully battery powered car like Tesla did, or the company pivots to have a hybrid still promising the disruption in pricing and partly using its secretive technology and partly a more efficient conventional technology or the company just falls apart running out of money since it is unlikely they can raise any more money without further conclusive and peer reviewed proof.
Silicon Valley is holding its breath and pinching its nose because it is starting to stink a bit. More than reputation is at stake.
It might very well make for a better movie than a company.
@vkt- Thank you very much. I wanted to put together a similar set of comments, but my instincts are only derived from following the Theranos story from multiple news sources filtered through a 77 year-old memory, and that isn't much of a platform to comment from.
Your experiences in SV have given you a first-hand insight into these kinds of things, allowing you to provide a very insightful summary of the situation. Your observations completely agree with mine.
Comments
1. Mutual funds amongst money from Russian "mobs" and Chinese transfers made Unicorns possible.
See my earlier post explaining how unicorn valuations come about
http://www.mutualfundobserver.com/discuss/discussion/25268/the-story-of-unicorns
The late stage funding arrangements have very little to do with valuations but rather the terms of the funding.
2. The mark-to-market that mutual funds have done have very little correlation with the valuation of companies which is determined by the next funding event or IPO. Because each funding round has its own terms including liquidation preferences, a new round can come in at an even higher valuation than before if the terms are right. This may lead to earlier round investors having to take a write-off on their investments to mark to market as they go down the pecking order of preferences or get diluted with new shares issued.
3. Unicorns are facing potential down rounds recently but this has nothing to do with mutual funds investing in them. It is all about the exit potential with IPOs becoming dimmer and the perception that the era of free money with increasing rates is coming to an end to raise even more funds.
If Theranos, the $9B unicorn health care darling of Silicon Valley (and the media darling because of the photogenic founder) which has over-promised and under-delivered, falls down in its own hubris, it will bring down many unicorns more than anything else. It has no mutual fund investors.
Regards,
Ted
List Of Unicorns:
http://fortune.com/unicorns/
The technology does have a 'black-box" quality to it, as it hasn't gone through routine peer review testing, but is relying instead on the FDA for this verification. This has a local flavor for me, as the Cleveland Clinic stepped forward to establish a partnership with Theranos, with the Clinic doing this testing and verification external to the FDA.
If this turns out to truly be a viable technology and the company goes public, it may be the most anticipated IPO in years.
Here is a reasonable recap of the company:
https://www.washingtonpost.com/news/to-your-health/wp/2015/10/16/a-comprehensive-guide-to-theranos-troubles-and-what-it-means-for-you/
press
walgreens.com/pharmacy/lab-testing/home.jsp
Walgreens has stopped its expansion plan pending further data/clarification. Safeway deal fell through as Safeway walked away.
Cleveland Clinic has distanced itself stating that it has not tried or evaluated the methodology or the product.
CEO promised to release the results of studies after the first WSJ article but has not done so.
The Board keeps changing its composition and has had some influential people but questionable choices. The Stanford professor who was initially on the advisory board and gave it credibility has quit the board. The lead scientist killed himself many years ago and his wife has claimed that he was ranting "Nothing is working at Theranos".
There is no management team except the founder CEO and a COO who is considered a sycophant and of dubious ethics. Has been accused of asking employees to use only the comventional machines for results submitted for FDA approval based on some emails.
Most of the tests are currently being done either using conventional equipment from Siemens etc or outsourced to third party facilities paying many multiples of what they are charging their customers, in other words burning VC money.
The star VC in its lineup DFJ is trying to distance itself stating that it only provided the initial seed money and did not participate further. Crunchbase states otherwise. A VC in Google Ventures came out to say why it didn't invest in Theranos and Theranos shot back it rejected them.
It is a very complex situation even in Silicon Valley which is used to a lot of hype and not at all black and white brilliant/fraud/scam clarity outside world wants.
My perspective without any private or inside knowledge about this secretive company but with having been in the startup grind through good and bad times:
It is a story SV badly wants to be a success for everyone's sake but privately afraid that it might become a black eye.
It has all the characteristics SV wanted, a female Steve Jobs, a disruptive technology company that had real value to society unlike Snapchats and such, fight against established and dominant industry, etc, etc. It can be very lucrative for the area with a successful IPO which would prop up other unicorns.
It did a lot of things startups fail to do and so fail even with a good product. It marketed itself well. Did the right outward facing development in anticipation. Realizing that like Uber, the biggest hurdle would be regulatory in nature, stocked up on high powered individuals on its board which at one time included Henry Kissinger. Knowing that the defense industry could very well be the biggest and most lucrative customer for this product, got people with military and government connections into its board. It raised enough money so that it would have a long runway.
It struck a partnership with Cleveland Clinic to gain credibility and got a marquee customer Walgreens. The media adored the Founder CEO.
Everything was going great, except the product itself...
The founder Holmes seems to be one of those rare individuals (have never met her myself) that are able to talk otherwise reasonable people into doing or believing what she says. People say that it is because she is a young and pretty woman. It goes much beyond that because I have seen similar power in a few people (even worked with one of them) that weren't women or pretty. It is the same charismatic hold cult leaders have where followers suspend disbelief. But even industry leaders fall for this. The reality distortion field that people attribute to Steve Jobs has components of that. When I saw this firsthand with the person I worked with, I just couldn't believe it. At first I thought it was some kind of hypnotic trance or some kind of blackmailing when this person got fairly influential people to do amazing things for the company where they didn't have to do anything. Most successful CEOs have some of this but not always at that level.
Having been in the ups and downs of startup cycles, I am not going to claim this to be a fraud scheme even with things falling apart as I have listed above. Startups are like baseball teams with bandwagon fans. When things are going great, everyone wants to be associated with you. When thiñgs aren't so great, they won't return phone calls or invite you to come to their hospitality suites in ball games as they used to and some will even start to badmouth. It is all part of the game.
What I suspect happened is that the promise and potential even within the CEO's mind quickly outdistanced the product development. It happens. When Elon Musk started Tesla he was very naive about what is needed to build a production car but was in love with the promise and potential of the technology. Had to face the realities very soon and went through a similar phase, throwing the initial founder out, being accused of running a scam, etc. But the product eventually caught up sufficiently to survive.
It is a bit more extreme in the case of Theranos because the persuasive powers of the founder seems to have started the hype/promise rolling faster than I suspect even she anticipated. Because lining up these things typically take a long time you don't want to wait until the product is completely ready, except she may not have realized her own powers to get things moving.
It is like the scene in IronMan when Robert Downey Jr, discovers the power of the propelled suit and bounces around without much control but enjoying that power nevertheless. And once you have that ball rolling, you don't want it to stop. Just hope that the product catches up. It had all the ingredients of a market waiting for you with fame and fortunes and all you had to do was carry the ball past the goal posts.
It is my suspicion that the product development ran into serious problems in not being able to deliver on the initial promise for all the tests they wanted to do. It is not clear whether they were simply unable to do the tests or whether the test results were not reliable enough to commercialize. Whatever it is, the CEO had very little choice at that point other than to buy time hoping the product would catch up so they started to use conventional machines and outsourcing tests losing money and being extremely secretive about it.
People may fault her for it but this is what happens in Biotech all the time even with many of the public companies, people here may have in their portfolios knowingly or not.
The best case scenario is that the the original nano product of testing with a pin prick improves enough to become a reality like a fully battery powered car like Tesla did, or the company pivots to have a hybrid still promising the disruption in pricing and partly using its secretive technology and partly a more efficient conventional technology or the company just falls apart running out of money since it is unlikely they can raise any more money without further conclusive and peer reviewed proof.
Silicon Valley is holding its breath and pinching its nose because it is starting to stink a bit. More than reputation is at stake.
It might very well make for a better movie than a company.
Your experiences in SV have given you a first-hand insight into these kinds of things, allowing you to provide a very insightful summary of the situation. Your observations completely agree with mine.