As the graphic below shows, the number of companies in the Unicorn Club is exploding and this is making us extremely cautious. Udacity joined the Club as the latest EdTech addition in November. Udacity has now raised $169M, most recently at a $1B valuation, on an estimated $24M in revenue. Earlier this year, LinkedIn created another ed tech Unicorn when it bought Lynda.com, who had raised $186M and had revenues of $150M in 2014, for $1.5B

Ed Tech Crowded Unicorn Club

We all need to ask ourselves, what would Benjamin Graham say? These very high valuations may offer exit opportunities for earlier investors, but buying into the “bigger fool theory” and “pyramid schemes” is not an investment thesis that we employ. Ultimately, the present value of future cash flows must be purchased at some discount. If not, there will be more companies like Amplify (which attracted over $1B from NewsCorp) and Power School, both of which were ultimately sold at significantly lower prices than dollars invested. Providence Equity’s $1.6B purchase of Blackboard is not looking good at this point either.

Although the education industry is still in the early innings of fundamental reform and transformation, New Markets is not convinced that an environment of high valuations will continue given the onset of pressure from public institutional investors to rationalize valuations. Most recently Square was in the news [1] as its IPO price/share could potentially be 29% lower than its last private market valuation given the pricing range discussed. Additionally, Fidelity recently marked down its estimated value of its holding in Snapchat by 25% in September. [2]

Further we do not believe that current valuation levels of non-proprietary deals create attractive investment opportunities. It is a better time to raise capital for, and exit out of, our portfolio companies. We are confident that valuations and expectations will rationalize over the next 12-24 months, and we will be well positioned to capitalize on this correction.

In the meantime, we are increasingly focused on creating proprietary deals that offer more attractive valuations and there are some savvy entrepreneurs that understand the true “intrinsic value” of their firm. As shown below, the average exit values for education companies is $200M.

Average Exit Valuations for EdTech: 2012-2013

A basic 5X return on capital would allow for $20M to be raised in total, if it represented a 50% ownership stake. Assuming at least 2 investors in the round, firms can put up to $10M to work in each deal and valuation should not exceed $40M in order to achieve a reasonable return. When companies raise $20M “B” rounds and $60M “C” rounds, with $160M post money valuations, investors wanting even 3-4 times their money will need to see companies exceed $100M in revenue to provide these returns or else face down rounds, recaps, and ultimate collapse under the weight of the preference stack.

In the long run, Benjamin Graham will always be right. A company will ultimately be priced at reasonable multiple of future cash-flows. We continue to employ our value investment strategy and buy and build the most efficacious education companies in the industry at the right price. In the meantime, we will continue to sell into the bubble, ready to invest aggressively when it bursts.

[1] WSJ Nov. 6, 2015 “Square’s IPO Terms Put Valuation Below Latest Funding Round”

[2] WSJ Nov. 10, 2015 “Fidelity Marks Down Value of Snapchat Stake by 25%”