The Public Company Discount

 

by Mike Feinstein

Don Dodge wrote recently about public company valuations vs. private company valuations.  This is a subject that is near and dear to my heart.

You can find many examples of public companies that have solid businesses and very low valuations.  Most public tech companies that are financially stable and have enough revenue to be sure to be around for a while are valued at less than 1x revenue these days, plus cash.  Think about that in terms of a start-up:

What's a start-up worth that has $15M of revenue, runs at break-even, and has $5M in cash?  In more typical times, you might expect this company to raise money at $40-70M pre-money, depending on what the long-term upside is.  Currently, a public company with this financial profile is probably valued at less than $20M, including the cash.

This class of public companies are really forgotten.  They are too small to be tracked by most analysts.  They don't trade at very high volumes.  They sound a lot like private companies, but they have the transparency, and costs, of being public.  Investors can probably get a venture-type multiple on these types of companies, with less risk than that start-up.

I think that these types of opportunities will definitely compete with private companies for capital.  In fact, I'm betting on it...Limited Partners of venture capital and private equity funds are starting to see that this is an interesting complement to their usual investing.  They do have the asset allocation issue that Don mentioned since their alternatives are a higher percentage of their portfolio than they would like.  But, as that returns to normal, I expect some capital to flow toward more VC-like investing in the public market.

And, what happens to that start-up that has the attractive financials?  They'll get financed, but they may not get the valuation that they would like.  If they are really cash-flow break even, they'd be better off tapping some debt until better valuation times return.