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Is the Latin American Startup Bubble About to Burst?

As startups fight to prove their ability to generate revenues and to justify their billion-dollar valuations, Bloomberg Línea talks to entrepreneurs and investors about the current panorama

Image by Bloomberg Línea
June 17, 2022 | 12:55 pm

Mexico City — Immersed in market uncertainty, are unicorn startups in a bubble that is about to burst? In Latin America, the last two years have seen an explosion in the number of startups with multi-million-dollar valuations and, probably, overt confidence among investors in business models that, for the most part, have not yet proven their profitability.

This causes some analysts to compare this moment with the dotcom bubble of the early 2000s, in which hundreds of Internet-related entrepreneurs became millionaires in just a few months.

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According to data compiled by academic portal Economipedia, in total, the dotcom boom caused technology companies to lose $5 billion in value between March 2000 and October 2002.

Just five years later, the real estate bubble began to develop, due to the default of subprime mortgages in the United States, which dragged the whole world into a financial crisis. During the recession between 2007 and 2009, the amount lost was even greater, according to figures from the Federal Reserve, an estimated $14 trillion, the equivalent of one year of U.S. economic activity.

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Corrections amid inflated expectations

There are those who consider that the current reality in which startups survive is different however, due to several factors.

“This financial crisis is not similar to last year’s crisis, it has been compared to the dotcom crisis or the real estate crisis, but the reality is that we are living in an unprecedented moment in which we have come out of a pandemic that interrupted production lines and high levels of inflation ensued, derived from the incentives in the United States”, according to Iván Guzmán Morales, a partner at BlackBox Startup Law, specialized in providing legal advice to startups.

He says that we are currently seeing the approach of a correction phase in venture capital funding.

“Contrary to the mortgage crisis and the dotcom crisis, in which a chain of events unleashed an abrupt fall, what we are seeing is a more gradual adjustment, which will translate into less financing, and will compromise many business models that had high growth,” Olaf Cárdenas, an academic and business expert at the Universidad Panamericana in Mexico City, told Bloomberg Línea.

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These dotcom and subprime bubbles were to some extent caused by poor risk analysis. But Cárdenas believes that certain lessons have been learned from past crises. “We have learned to strengthen the analysis, in a much more quantitative way, which has delivered better results to investors”, he says.

“The sin of this phase, of this bubble, was that we took quite aggressive macroeconomic scenarios and economic growth that, in truth, were not sustainable in the medium term,” says Cárdenas, who is also a senior associate at Besant private equity fund, dedicated to venture capital investments.

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Another lesson is to be quite cautious and conservative in terms of macroeconomic growth expectations, he says.

“We took for granted interest rates that were quite low and prolonged over time.”

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We are going to see all this correction and purging of companies between those that are profitable and sustainable and those that cannot cope with all these business models without financing, Cárdenas adds.

Will some unicorns disappear?

Now that the world is facing a drop in valuations of public companies that are comparable to unicorns, this affects expectations for future valuations in subsequent rounds.

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Carlos Ramos de la Vega, director of venture capital at the the Latin American Private Equity Investment Association (LAVCA), believes that against this backdrop, current valuations could be modified.

“Definitely, given the adjustment in the markets, some companies will see a reduction in their valuation, but others may also see an increase, it depends a lot on the position in the market,” Ramos told Bloomberg Línea.

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“Several of the unicorns, I dare say, may lose their unicorn status, and I think we are also going to see fewer and fewer,” Cárdenas says.

There are several examples of public companies comparable to unicorns that have suffered plummets in the value of their shares.

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Shopify (SHOP), an e-commerce platform for online stores, has lost about 80% of its share value in the market. For Argentine unicorn Tiendanube, Shopify is its public company comparative and, to which investors compare it. Shopify’s decline could represent a problem when it comes to sustaining its $3.1 billion valuation.

There is also the case of Opendoor (OPEN), an online company that buys and sells residential real estate, based in San Francisco, which has also suffered falls in its shares. Its unicorn comparatives in Latin America are Brazil’s QuintoAndar and Loft, and Colombia’s Habi.

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In the case of QuintoAndar and Loft, they have had to restructure and, as a result, have laid off staff. Both startups have laid off around 160 people, according to sources familiar with the matter in Brazil.

Although Colombia’s Habi seems to be going against the tide, it was only added to the list of Latin startups valued at more than US$ 1 billion last May.

Carvana (CVNA), the US used car dealership, is another example of a public company that has seen its shares plummet in the last nine months. Its comparison in Latin America is the region’s most valuable unicorn, Kavak. However, according to experts, if the domino effect does arrive, it will take about 12 months.

However, given the different realities in the U.S. and Latin markets, comparables are only one variable to consider. Michelle Fischman, head of platform of the Mexican venture capital firm Nazca, says that before talking about a bubble, each particular case must be taken into account.

“On the one hand, the real traction of each company must be analyzed -generation of value for its users without subsidizing revenues, market share and growth potential, etc. - and, on the other hand, and very importantly, unit economics and the path to profitability must be reviewed,” Fischman says.

So, could we be talking about a unicorn bubble?“

We talk about a bubble when companies do badly, but this may not be the case; we must remember that Google, Facebook and Amazon were startups once and are now the most important technology sector in the U.S. stock market,” adds Iván Guzmán, of BlackBox Startup Law.

Are unicorns more attractive post-IPO?

WeWork (WE), a firm once valued at $47 billion, had a complicated IPO.

The shared office space startup had hoped for a successful IPO in 2019, but it seems the company became something of a poster child for the excesses of venture capital and startup culture in the post-2008 era.

Doubts arose among investors about how fast WeWork was burning cash. So the company had to make adjustments -- most notably a CEO change -- and postpone its IPO. And it wasn’t until 2021 that it managed to go public with the help of a special-purpose acquisition vehicle (SPAC).

However, WeWork’s $47 billion valuation when it was a unicorn does not compare to the approximately $9 billion revaluation after the merger with a SPAC, BowX Acquisition Corp.

In localized cases in Latin America, Nubank (NU), once the region’s most valuable unicorn, worth $30 billion, gave up its mythological title to become a public company and list on the New York Stock Exchange in December 2021.

In that case it was a positive IPO, as the stock achieved a price of $9 in its initial public offering, raising the valuation of the Brazilian neobank to $41.4 billion, making it the most valuable financial institution in the region. This represented a milestone in the history of Brazilian unicorns.

There is also the case of Uruguay’s only unicorn, payments fintech dLocal, which debuted on the New York Stock Exchange in June 2021. Its entry into the public markets was through an IPO, the high demand for which during the previous day raised the placement price from between $16 and $18 initially expected to $21 per share. This brought the value of the Uruguayan fintech to around $6.15 billion, more than what it was worth when it was private: $1.2 billion.

Lately, however, stock market tumbles have also had an effect on these two former unicorns. In May, Nubank and dLocal shares fell 48.6% and 41.8% respectively, according to a Bloomberg Línea analysis.

Survival of the strongest

LAVCA’s Carlos Ramos de la Vega maintains that there is “a healthy degree of optimism in the ecosystem in the medium and long term, due to two important issues: firstly, because the fourth quarter with the largest investment in Latin America occurred last year, and secondly, we are seeing several funds that are launching funds specifically dedicated to Latin America, even though their global fund is based in the United States and they are expanding with offices, either in São Paulo or Mexico City”.

In the same vein, Guillermo Cruz, managing partner of Maquia Capital, tells Bloomberg Línea that Latin America still has a lot of potential for unicorns, as there are many business models that are solving specific problems in the countries of the region.

“I think there are many niches that Sequoia or SoftBank are taking advantage of to invest capital,” says Cruz in reference to two of the venture capital firms active in the region.

And Ramos agrees that there is still a lot of growth potential.

“It makes a lot of sense to justify slightly higher valuations and, at the same time, that investors can write slightly larger checks than in the last five years, for example, so that obviously helps to increase valuations,” he says.

So will the Latin American unicorn boom continue? “I wish I had a crystal ball,’’ Ramos jokes. “What we see in conversations with investors is a refocusing of priorities toward capital preservation of portfolio companies they already invested in in previous periods, and at the same time on continuing to invest, but perhaps with slightly more leisurely periods of diligence”.

Cruz, who already has a unicorn, Colombian proptech Habi, in his investment portfolio, is cautious in his forecast. “Maybe now it will be a little more difficult for there to be more unicorns, of course there will be, but they will be safe bets, because the market will begin to consolidate”, he says.

Ramos considers that the record investments in startups in Latin America last year “was very useful to provide global visibility of Latin America as a region, not only of the main countries, but for example the listing of dLocal, on the Uruguayan exchange”.

This shows that the Latin American market is promising beyond a couple of quarters, when there may be fluctuations in the market, Ramos says.

Guzmán, who is an expert on advising startups, believes that in these times of crisis even these business models can be countercyclical.

“Startups behave very differently to traditional companies, and can even flourish in times of crisis; they have a lot of value because of the technological support, which allows them to operate without borders,” he says.

The BlackBox Startup Law advisor predicts that Latin American unicorns will become even more valuable as technology adoption becomes more widespread in the region.

Maquia Capital’s Cruz has a positive view as well. “I think that the unicorns that have existed so far in Latin America are scaling very quickly. For example, Habi has grown 105% from January to now”, he says, and he does not see a speculative bubble.

Fischman, from Nazca, adds that the unicorns that were born last year raised investment rounds of a relevant size, “which leads them to have enough cash to face the coming months and continue growing at a pace that puts them in a better situation”.

Ramos reaffirms that “unicorns have to grow to be able to justify that valuation in the coming quarters and put the capital they have to work in the most efficient way”.

Only those unicorns that have real value and growth potential, and not a simulated one, will emerge victorious from the crisis the world is going through, he says.

Cárdenas concludes that “only those that are really efficient and sustainable in the short and medium term will survive. Then we are going to see how, little by little, some companies will go bankrupt, possibly in about 18 months”.

Translated from the Spanish by Adam Critchley