Late last week, a Crowdability subscriber emailed me with a tough question:
“How am I supposed to make money investing in private start-ups when they’re already valued at billions of dollars? How much higher can these things go?”
With Pinterest recently valued at $11 billion, Airbnb at $25 billion, and Uber at $51 billion, plenty of smart investors are asking the same question.
So today we’re going to reveal an intriguing investment strategy:
It allows you to profit from the dramatic rise in start-up valuations—without investing in the start-ups themselves.
And to use this strategy, all you need is a basic brokerage account.
To The Moon
From angel investors with a few thousand dollars, to venture capitalists with millions, to hedge funds with billions, it seems that everyone is trying to profit from investing in start-ups nowadays.
Look at Tiger Global, one of the most prominent hedge funds in the world:
Until recently, they were best known for their public-market investing…
In the span of just a few months, however, they raised two $1.5 billion funds to back later-stage private companies such as home furnishing site One Kings Lane, and eyeglass company Warby Parker.
But as funds like Tiger come to the private markets with more and more capital, the “valuations” of private companies are getting pushed to the moon.
“Valuation” is the private-company equivalent of a public company’s “market cap”—and paying attention to it is an essential part of making money in private equity:
The fact is, no matter what you’re investing in, you need to buy low and sell high.
But with so much money being poured into later-stage private start-ups recently, “buying low” is getting challenging…
In fact, today, 128 private start-ups are already valued at over $1 billion.
To put that number in perspective, if you look back at private companies in the year 2000, you’ll find that just 10 of them had valuations above $1 billion.
Alternative Strategy: Go Public
Amidst these eye-popping statistics, a new investment strategy is emerging…
Simply put, instead of investing in a billion-dollar private company, you could invest in a publicly-traded company that competes with the private company—but trades at a relatively low price.
One investor leveraging this strategy is a San Francisco-based hedge fund called Pier 88 Investment Partners.
Pier 88 believes that, as companies seek to compete with high-flying start-ups such as Airbnb, certain public companies will become attractive acquisition targets.
And if those public companies get acquired at a premium from where they’re trading today, investors can make outsized profits.
Here’s an example of how Pier 88 has used this strategy:
Recently, the home-rental start-up Airbnb was raising funding at a $24 billion valuation.
Meanwhile, a public competitor of Airbnb called HomeAway (NASDAQ: AWAY) was trading at a $2.95 billion market cap—in other words, at an 85% discount to Airbnb.
So Pier 88 bought shares in HomeAway.
It employed the same strategy in the “collaboration software” market:
Instead of investing in a private company called Slack which was valued at $2.8 billion, it invested in a public company called Jive (NASDAQ: JIVE), which had a $292 million market cap.
As one of Pier 88’s founders said:
“People think there’s something inherently wrong with public assets because they’re cheaper. But if I’m buying decent assets at a relative discount to the private marketplace, the risk-reward is probably in my favor.”
Proof’s in the Pudding
Does this strategy work?
Well, despite the fact that this strategy requires patience—it takes time for a company to be acquired—it certainly seems to be working for Pier 88:
Since its inception 22 months ago, seven of its portfolio companies have already been acquired.
One acquisition was the B2B marketing company Responsys…
Oracle acquired Responsys for $1.5 billion—that's nearly triple its price from the year before.
Another acquisition was the “Big Data” leader, Informatica…
Informatica was bought out for $5.3 billion, which makes it the single largest private equity buyout so far this year.
Kenneth J. Heinz, the president of Hedge Fund Research, a a global leader in the area of performance analysis of hedge funds, had this to say about Pier 88’s approach:
“The easy private financing environment has created an interesting trade opportunity. With such a disparity between public and private multiples, it’s a reasonable fundamental approach to believe that in this environment, the public company valuation will come up or the company will be acquired.”
128 Takeover Targets
If you’re looking for home-run type returns from start-up investing (i.e., 10x or more), you should look at early-stage deals like the ones we typically feature on Crowdability >>
But if you’re looking to take advantage of the boom in later-stage deals without investing in start-ups directly, consider using the Pier 88 strategy:
For example, instead of investing in Uber (recently valued at $51 billion), you could invest in $8 billion car-rental company Hertz (NYSE: HTZ).
Or instead of investing in the storage start-up Dropbox ($10 billion valuation), you could invest in Box (NYSE: BOX), with a $1.75 billion market capitalization.
To find similar investment ideas, peruse this list of privately-held companies…