Theranos: Unicorn Valley’s Madoff Moment

By Mark St. Cyr

To refresh one’s memory: it was in December of 2008 when Bernie Madoff admitted and subsequently arrested for what is considered the largest financial fraud in history. The main reason for his coming clean? A change of heart? Far from it. It was only for the reason he could no longer hide his pie-in-the-sky metrics (along with payouts) against a backdrop of such financial chaos and reality.

It wasn’t that he could no longer fabricate those metrics any longer. (i.e., for they were all made up to begin with) It was primarily for the fact that even he knew discovery was now inevitable. Why? It was becoming evidently clear for anyone with a modicum of business or financial sense (no matter how much they didn’t want too) that something was wrong. And he knew it. The time scale for discovery had moved from “maybe someday” to “any day now.” He just relinquished first.

Theranos™, in my opinion, has many of the same overtones for what transpired during, as well as, in the aftermath of the Madoff scandal. And the residual implications are not only yet to be seen. The consequences that are about to reverberate are going to bring forth reckonings many believed would never come. At least that is – before they could IPO, cash out and avoid it themselves. But if 2016 is any clue? Avoiding might no longer be an option.

In “The Valley” the last 7 or 8 years has seen a morphing of true business fundamentals into a place of pure financially adulterated fantasy.

Here is where the story changed from “Something built that customers love and will pay for.” Into “Build something that can give the illusion VC’s want to see and hear so they can pay for the right to then sell that illusion to Wall Street and we all get rich.” True business metrics or morals be dammed. (for a reminder about morals just enter “Secret” into your search engine of choice.)

So why do I use Theranos as the “Madoff Moment” reference some may be asking. Well, to put things into perspective I’m going to take some artistic license and employ some very general, over arching, big blanket statements for comparison purposes. For it’s the context which is more important for understanding – not the exactness of times, dates, amounts, or players et al. So with that said…

Theranos is both large enough and its figurehead famous enough to be a household name within an entire industry. Everyone who had anything to do with startups, unicorns, investing, entrepreneurship and business celebrity (especially when it came to the three-comma-club) knew of both the company, as well as, Ms. Holmes. Same for Madoff. Both the claims of what their company was, and could do, was celebrated with unmitigated praise and envy. Ms. Holmes with her amazing amount of tests with such a small sample of blood drawn. Madoff with his amazing stable profits year after year with no bloody draw downs.

Both Ms. Holmes and Mr. Madoff were held up as “celebrity” in their own light. Not once, or twice. Rather – year upon year.

For years there were articles and interviews on how wonderful and genius these people must be. Questions into their true performance whether it be their company or methods was met with evidence which, for the most part, went unchecked, unverified, and unproven. If that statement is wrong – then how could it had gone on for near a decade with Ms. Holmes, and a few decades with Bernie?

No; questioning and careful scrutiny of extraordinary claims wasn’t the first order of concern – praise and awe was of the first order where I’ll add – first, and the only ones at that.

Any of those pesky details that might ruin that narrative didn’t get in the way of such a good story. At least that’s how it now appears. Again: if I’m wrong? How could it have happened for so long? And that’s the key fact which can’t be brushed aside. e.g., “so long.”  There’s just no other explanation.

Now It appears that both have finally suffered from the same fate: Once the money dried up (for Theranos it was no IPO, Bernie was the market melt down) all eyes begin to look closer and harder at what you’re doing.

Questions become more pointed. Results are more closely scrutinized. And the more you say you are able to deliver? The more that expectancy of delivery is demanded.

Theranos needed to prove it could deliver what it said because people now wanted their money (as in IPO.) Same with Bernie – you can’t hide how you’re paying for any redemptions forever. Especially when the “street” knows people are calling for them. Remember, trades are recorded and publicly available and must be reported to the SEC. When it was demonstrably clear and noticed that none of Madoff’s trade history matched up to markets – the jig was up.

Theranos seems to have befallen a similar fate. When the needed documentation was called for (and I would guess was being demanded as to prepare an IPO) the medical regulators finally caught up when it was clear – there’s no there there  – when it came to its technology. Here too – the jig was now up.

However, I am of the opinion this is where the real story begins, not ends for both “The Valley”, as well as, its stable of unicorns. For much like what happened after Madoff with the relentless wave and wake of claw-backs along with the sheer upending of confidence as to who was worth what, or who stilled owned what, based on years of what was being deemed as ill-gotten gains or proceeds garnered from Madoff’s fund shook many individuals, as well as, other funds to their very core.

People seem all too willing to forget just how shaken anyone holding a “portfolio” of any kind never-mind one handled directly by Madoff felt during the following two years of ’09 and ’10. Nobody trusted what “the numbers” were supposedly touting. And most importantly – no one was buying it any longer. Both figurative, as well as, literal.

How shaken was this confidence which some need reminding of? So distrustful, so disgusted, and so put off were not only investors of all sorts, but for that matter, people in general at the scale of fraud which by all accounts was hiding in plain sight – they left the markets and have never returned. And what took place as to fill that void? Enter quantitative easing aka QE. For without it – there was (and some of us still argue) no market.

And with that you have the rise of “The Markets” along with its representative mascot of fiction parading as real: “The Unicorn.”

Again, for a little perspective: Madoff wasn’t the cause of any further disenchantment. What the Madoff scandal did was punctuate, and put a face on what everyone had an inkling was taking place to begin with.

CDS (credit default swaps) and securitization of all types of loans to unknowing, and for some, uncaring investors enabled people who more than likely should not have been able to get loans not only get them – but saddle themselves with so much debt the horse died in-place under the pile where no one noticed or cared to look. That is, until finally the odor ranked so heavily – it could no longer be ignored.

Ah, but then a new horse emerged. Stronger, better equipped. Needing far less initial investment to make people appear far richer than what could conceivably be done with general accepted business metrics or math. So cute and child friendly was this new mascot and all it seemed to encompass of “the new world of tech” it lent itself willingly to become the latest sock puppet mascot to represent the impending issues flying both above, around, and beyond “The Valley.” Enter: The Unicorn.

I know there are people chomping at the bit right now as to argue about how some unicorns of the past have become some of the largest tech giants today. I get that. However, like I’ve said so many times before: How do they stack up using GAAP  not Non-GAAP? And if you look at far too many of their current valuations? Well, you just go ahead making those arguments is all I’ll say.

However, if you’re so inclined – you can send your findings and defenses directly to the SEC. For it’s they who would like you to remind them once again exactly how those “metrics” came to be. Not me. For it seems even they have come to the conclusion of “Wait what?” when looking at many of today’s reporting. So much so they’ve decided it’s time to make official inquiries.

I’ve argued ad nauseam for years about many of the valuations along with the creation and thinking behind them as to why they never made sense. And it’s coming to light that many never have, and never would, prove out those metrics without the heavy-handed sprinkling of Non-GAAP fairy dust.

I have always been of the mindset and opinion they were nothing more than what their emblematic mascot represented: a fairy-tale. Period. And Theranos, much like Madoff, is a watershed moment that puts reality squarely at the forefront and can no longer be swept under the rug; hidden, spun, or any other descriptor one wants to use.

Even to a layperson – the reality of the farce can no longer be hidden. And the more it’s tried to be spun away with rinse cycles that would make a washing machine blush? The more incredulous people become.

There are a few revelations as reported by Forbes™ which are germane to these insinuations. (and just in case you missed it, they revised Elizabeth Holmes net worth to ZERO. Imagine that. $4.5 BILLION to nothing. Think a headline like that isn’t making its way around “The Valley” faster as to make a laser employed bid ask spread jealous? Hint: you bet it is.)

Here are the one’s which in my opinion change everything in ways most don’t fully comprehend as of yet. Along with the damaging of psyche of many residing in not only “The Valley” but the tech world in particular that will morph ever the larger and become unquestionably “a force to be reckoned with” in the very near future.

One of the first is this one:

“…plus new information indicating Theranos’ annual revenues are less than $100 million, has led FORBES to come up with a new, lower estimate of Theranos’ value.”

Read that above quote again, very slowly, and ponder it very carefully.

Don’t think there’s much to that above revelation? Add it to this one while once again doing the same. Ready?

“…a more realistic value for Theranos is $800 million, rather than $9 billion. That gives the company credit for its intellectual property and the $724 million that it has raised…”

Theranos has been a Billion-Dollar-Baby not for a day, week, month, or even a year. But years. On what type of revenue? $100 Million. And that assumes $100MM is the most recent as well as best current representative.

As bad as that is (and I’ll state it’s not just bad – it implies criminality) what were the revenues years ago when it first joined the coveted “three comma valuation” club? Or said differently: What enticed $724MM to invest which is said to represents near 75% of its total value? Hint: I’ll wager more story telling than that contained in Aesop’s Fables.

This (again, all in my opinion) causes two problems for not only the early investors in “unicorns” in general, but also, for the remaining unicorns themselves. And they are these…

First: How can one believe the metrics of any unicorn when such a high flyer as Theranos is exposing just how tainted, manipulated, as well as, the possibility for out right criminal lying that made or reinforced those metrics? Putting things into context: the only story line gaining more credibility by the day for this unicorn is the incredible story-line about how deeply its lying may have gone with every newly exposed data point.

Now, just like when the Madoff scandal hit – everything is beginning to be questioned. And I’m not just talking about Theranos. I’m talking about things like the current claims or net worth of those early, as well as, subsequent investors in the round after round of Series ABC thru LMNOP and sometimes why funding extravaganzas. Let me put it this way using the following hypothetical.

Let’s say you invested $1Million dollars in early rounds at Theranos. For years you were thought to be worth who knows how many $Millions, if not $Billions of dollars in resulting net worth once Theranos went public. Do you think (or at the lease assume) some were given access to credit or other such exclusive vehicles when it came to loans and more based on this presumed net worth? Never forgetting – they’re (e.g., unicorns) presumed to be worth that much because – they tell you they’re worth that much. And you thought a NINJA or Liar loan had issues. But I digress.

Maybe I should ask it this way: Do you think Ms. Holmes was living a lifestyle afforded her via the banks or other creditors on what they assumed was her $4.5 BILLION dollar net worth? Or, do you think it was based purely on her verifiable salary with some “extra credit” thrown in for her stake in the company?

I’ll wager dollars-to-doughnuts banks and everyone else on the planet who specialized in “band wagon jumping” or “coat-tail riding” lined up and gave loans and more as to take part in those presumed riches. Of course with the intention of you being able to pay it back, with a fee mind you.

Oh, oh. Suddenly today one’s collateral might look a little shaky, if not out right shady. Here’s where the term “margin call” takes on a meaning never before fully understood by many of today’s tech crowd. All I’ll say is this: It’s not a call or invitation one wants to receive. Unlike a multi-million dollar company afforded costume gala – this one has onerous un-hidden consequences and is deadly serious.

Bought a McMansion or extended a line of credit based on what a bank or others deemed as your net worth or assets? Were those “assets” all based on your Theranos investment? Can you see the implications for an ever-growing spiderweb of questioning, as well as, outright calling in of loans of all sorts? To who knows who?

Or are you of the mindset: “Nothing to worry about once I explain how it wasn’t my fault and I didn’t know. Surely my creditors will understand and work with me.” Sorry, but I had a hard time even typing that hypothetical line without bursting out in laughter, never-mind thinking of how many “creditors” would act as such.

As bad as that is – it can get worse. Much worse. For here’s another hypothetical:

Was that (or any) line of credit based on earnings or proceeds obtained (regardless of the timing) one had in Theranos? Whether one used it to buy similar stakes in other pre-IPO darlings or, to just sit on? You don’t need to be an SEC official or have a legal shingle to see the troubling doors just waiting to be opened.

Could one now suddenly find themselves with serious claw-back issues they never dreamed possible? A lot of investors, as well as, people (some relying solely on those proceeds) found themselves suddenly penniless after the Madoff scam broke out in earnest. Not because they did something wrong, but because the money they thought was legitimately theirs was determined, by law, to be of “ill-gotten gains.” e.g., from a scheme. Then subsequently taken back either by voluntary forfeiture or court sanctioned force.

Don’t take my word for it. You can look back yourself and find article after article of the devastation left by Madoff’s revelation.

However, like I said earlier, it didn’t or doesn’t end there – it begins.

Here’s the second issue that should not be lost on anyone, and why it’s far bigger to the overall picture than just some small detail to be ignored:

The group which could be most affect by such a revelation such as Theranos are the workers, dreamers, and big-eyed “I’m rich because I’ve got stock!” group of 20 and 30 somethings who bought into the whole “It’s different this time.” meme hook, line and sinker.

The more one tried to make them aware? The more staunch the response came back resembling the teenage inspired defense of “Well because!” And this wasn’t limited to the misinformed. No, this style of rebuttal was also employed by a great many that not only knew better, they in-turn yelled louder than most two-year-old’s when throwing a tantrum. And many of this cohort had lived through the last tech bubble!

So too say “I didn’t fully know or comprehend the scale today!” Will fall on deaf ears as this all plays out in the not so distant future. Many, and I do mean just that, a great many of today’s Valley aficionados are going to find their credibility running right along side what I can only assume will be a torrent of down-the-drain valuations.

Another line in that Forbes article which I am sure flew right by many a financial maven because of its commonality and well understood assumptions was not looked upon in the same light by some recently added participants to the current “tech boom.” And whom might that be you ask?

Current employees, as well as, the myriad of others who have visions of grandeur with IPO cash outs and unicorn dreams.

These are the ones working long hours with little to no pay in exchange for stock options and more. Some have bought so deep into the dream they are living in shipping containers or under stairwells of others as to “suck it up” until their pay-day arrives. And it is well ensconced the implied payday will arrive – not – that it might. That’s a distinction with a very big difference. Don’t let that be lost on you.

Oh, and that other line, or should I say lines? To wit:

“At such a low valuation, Holmes’ stake is essentially worth nothing. Theranos investors own preferred shares, which means they get paid back before Holmes, who owns common stock. According to VC Experts, investors in Theranos own a particular kind of preferred equity, called participating preferred shares, which take precedence to common stock in the event of a liquidation.”

So the question that will most assuredly be spinning around anyone’s head who is on the “work for stock” styled incentive plan will be this: If she owned 50% and now she’s worth nothing – what the hell are mine worth?” Again – regardless of which company they are in. This question will now be asked by an ever-increasing number. And the resulting answers may not be what any of them ever considered. Ever.

Back in October of 2015 I wrote an article titled “Crying Towels: Silicon Valley’s Next Big Investment Op” I reference it routinely for it was jeered by so many I’ve coined as “aficionados” taking to platforms as to out right mock, and pooh-pooh such observations. And in that article I posited the following:

“And this brings on a whole host of other meme shattering, break out the “crying towels” type arguments. For if it can happen there – guess where else it’s going to begin happening? Is ________________ next? Just fill in your current favorite high-flying Non-GAAP social darling on that line – for it’s going to happen at all of them very soon in my opinion. Much sooner than many now even think or ever thought possible.

“Coders” will gladly live in some single bed shared between 8 others apartment somewhere near the Valley. Heck. they’re now reporting stories how one can live in a shipping container on the cheap in San Francisco. Sounds fantastic right? Well, it is. As long as the dreams (and expectations) of landing the dream job in a start-up or similar where riches based in stock options and more are forthcoming or, dangled like carrots in front of wide-eyed dreamers.”

Now, here we are just 6 months later and you be the judge as to who was looking through the correct prism as opposed to a kaleidoscope?

To reiterate – I’m going to implore that you don’t shrug off this Theranos scandal and debacle as a one-off type representation. I am of the opinion this is far deeper with far more repercussions than most grasp. So much so I think it helps put more finality  to the question that so many in “The Valley” held up as both unanswered and more importantly unanswerable implying “it ain’t gonna happen” because “This time it’s different.”

Marc Andreessen (to be clear – this isn’t a slight, I’m a fan and respect his insights. I just disagreed with his current conclusions) for years one of the most vocal VC’s railing against the idea of a bubble currently taking place in “the Valley” used the following saying as to shrug off even the idea. It comes from the Warner Bros™ cartoon character Martin The Martian (one of my favorites by the way) “Where’s the kaboom? There was supposed to be an earth-shattering kaboom!”

Well, like I stated in February, The “kaboom” has not only been heard. It’s becoming more frequent, as well as, louder with an ever-increasing amount of dangerous fallout. So much so they can no longer be muffed by any amount of spin. As a matter of fact, the more spin, just like centrifuges, it increases the power with ever higher decibels for every  subsequent one that goes off. And I’m of the opinion: we’ve only entered into the overture portion where the main fireworks display has yet to come.

Source: Theranos: Unicorn Valley's Madoff Moment - Mark St. Cyr

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