Olga Kharif: Rise in mobile start-ups signals a bubble

Investors have jumped on the bandwagon as a diverse range of services has became available via smartphones. As a result, mobile internet firms that crossed the $1-billion threshold swelled. But the ec

The number of mobile internet start-ups with valuations crossing $1 billion has jumped by a third in just eight months and that's spelling trouble for some venture capitalists looking to cash in on their investments.

Already, there are signs of worsening returns. The ratio of mobile internet exits - start-ups that are either sold or go public - to investments has plunged over the past six quarters, excluding one outlier deal, according to consulting firm Digi-Capital.

"Mobile is frothy and bubble-like," said Rajeev Chand, managing director and head of research at Rutberg & Co LLC. Companies that would have got $8 million to $10 million in investments a few years ago were now getting as much as $50 million, he said. "There's way too much money going into mobile delivery companies. The economics are fundamentally not sustainable." (NO EXIT — AT LEAST FOR NOW)

Investors have jumped into mobile internet start-ups as services from dog walking to shopping to food delivery became available via smartphones. In 2014, global mobile data traffic was almost 30 times the size of the entire global internet in 2000, according to Cisco Systems Inc. As a result, mobile internet companies that crossed the $1 billion threshold - known as unicorns - have swelled to about 90 for a combined valuation of more than $800 billion, Digi-Capital said in a report last month.

It wasn't so long ago when there might have been 10 unicorns in an entire decade, said Matt Murphy, a managing director at Menlo Ventures. Venture funders, who typically recoup their investments in five to seven years, might have to wait two to three years longer and perhaps with less rosy results, he said.

WhatsApp represented a bright spot last year when Facebook Inc bought the mobile messaging service for $22 billion. Still, excluding that one deal, the ratio of exits to investments declined for six straight quarters, Digi-Capital said in the report. While investments in the second quarter amounted to $16 billion, exits were just $13.5 billion, half the $26-billion peak they reached a year earlier, the researcher said.

While in the past, venture capitalists (VC) tended to spread their money around, some were now pouring more into fewer companies, and their risks had skyrocketed, said Tom Taulli, a mergers-and-acquisitions consultant in Los Angeles. Firms, particularly those that stepped in during later funding rounds when mobile startup valuations were higher - could see losses, and have less money to reinvest. The amount of funds that firms have available for promising new companies could drop by 25 per cent in two years, he said.

"It's a high-stakes game of Russian roulette," Taulli said. "A couple of VCs are going to win, and many VCs are going to lose, and that's going to eventually shrink the funding into mobile and other areas."

To raise cash, some venture firms were starting to sell portions of their stakes in private companies to other investors, Menlo Ventures' Murphy said.

"Private-equity firms have always bought from each other," Murphy said. "We are starting to see more of that creep into the venture business," he said, in what he called "another liquidity path."

Still, with the mobile market in its infancy and growing fast, it will continue to attract venture capital.

"People are not going to cease to invest now because there's a shortage of exits," said Benedict Evans, a partner at venture firm Andreessen Horowitz in Menlo Park, California. "Yes you have to think about how you are going to get liquidity from that. There are worse problems to have."

All eyes will be on some of the high-profile mobile companies - such as Uber Technologies Inc, Snapchat Inc and Square Inc - when they go public. Uber, the car-fetching app, is valued at about $50 billion - more than six times the value of car rental company Hertz Global Holdings Inc and about $4 billion greater than the market cap of General Motors Co.

"If one or two of these evaporate, that's going to create a lot of fear in the market," Taulli, the M&A consultant, said. "I see few signs that the IPO (initial public offering) market is going to accommodate many heavy-losing companies with inflated valuations."

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