Digital Legacies: Valuation

With Tesla orbiting the 1 trillion market cap, it is no wonder it is seen as the future of the car industry. The next three big giants combined make about 460 billion. Volkswagen, Toyota, and Honda together do not make even half of Tesla’s market valuation. Volkswagen had a turnover of about $270 billion in 2020 when Tesla barely touched 14 billion. Tesla has combined good design with electric powered cars, and autonomous driving features. Like Amazon, which is considered by most as an e-commerce company, is infact a technology company like Tesla. That changes everything. The paradigm shift is about expectations instead of results. It is about possibilities instead of current behaviour. It is about disrupting markets instead of keeping a business model. It is about tapping into pent-up demand instead of trying to use advertising to create ordinary demand. It is simply the future instead of the past.

Technology companies always behaved differently from traditional business models. The playbook of American investors has not to do with companies making money first. It is all about conquering market share at the calculated cost that can be compensated by relatively short-term higher valuation. It’s been working like that for many decades now and have created millions of millionaires and a few thousand billionaires. The likes of Google, Microsoft, Apple, and Amazon, which are roaming around with $2 trillion valuation are of course on another level and have been generating revenues and profits for a long time. But Microsoft, for example, was seen as a company of the past for a few years and today has made a comeback through cloud computing and through the leadership of the young and smart Satya Nadella.

The valuation of companies works in multiples. That logic rained for a long time in the investment business as well as in the stock market. With technology companies it has started to work in a slightly different way but with a more radical variable: the future. Snapchat for example is valued around $85 billion, and that because it has suffered a lot due to the new privacy regulations from Apple. It has generated revenues of mere $2.5 billion in 2020. Its market capitalisation is all about its potential. The industry has focused on IP for a long time, but also in capillarity in important markets. Burning cash to get there is allowed as long as the metrics work. Valuation finally arises from another angle. The value proposition of a technology company must be quite clear, and usually, before these companies stand out, and even start acquiring other ones with investors’ money, they try to solve a very specific problem, which was not looked at in that specific way before.

The case of Tesla is quite unique for the fact that the auto industry is certainly one of the most solid businesses in the world. It touches almost all the other industries, from mining to oil and gas, from design to textile, from retail to road regulation, from glass to computing, from GPS to rubber, from plastics to lifestyle. It is really broad, and it is really important to provide jobs. But it has also been the jewel of the crown from many countries such as Germany, the UK, the United States, France and Japan. To disrupt such an industry is quite an undertaking. The other industry, which I have been part of, the publishing industry, has been really hard to change. I always joke the publishing industry is 500-years-old. But even in publishing, with all digital books and digital apparatus, it has been able to maintain its core quite intact. But the valuation of publishers has gone down dramatically. They do not represent the future anymore, and social media companies have taken over with new value propositions. Media conglomerates have been trying to sell their publishing assets for a long time, in most cases without success, because no one is interested in them anymore. They are interesting, but too complex to change.

At Investopedia, the enterprise value-to-revenue (EV/R) multiple is explained as a tool to help compare a company's revenue to its enterprise value, or market cap. In theory, the lower the better, in that, a lower EV/R multiple signals a company is undervalued. Generally used as a valuation multiple, the EV/R is often used during acquisitions. It indicates if the company is worth from a revenue generating standpoint. However, if you are buying a company which is strategically positioned to change your future, the price you would have to pay might be quite different, especially because the owners will understand the synergies of both businesses.

Finally, the stock market offers great fluctuation for technology companies for several reasons. One is privacy. When users understand that the company doesn’t match the desires of customers it can get in trouble. That happens often with data breaches for example. The other one is governmental regulation. It comes now more often than not because regulation for older industries is starting to become obsolete, and technology companies have been the target for the simple reason that they deal now with more dated than governments have in the past few hundred years and can through that control citizen’s opinions and behaviour. For the moment, the tech industry will remain the jewel of the crown. Investors will risk but will also rip profits. We will see which industry will be the next one to reign. Let’s keep an eye on the green industry. Or maybe a combination of the two.

Read more from the series Digital Legacies where our columnist Julius Wiedemann investigates the many aspects of digital life.