📊 The Coreweave IPO and the importance of incentives

John here this week. Spring has sprung and the NCAA tournament is in full swing. There’s something special about “march madness”. I love to see the college kids giving it everything they’ve got in the tournament each year. In my opinion, it’s the best sports event of the year. Best wishes to you if you filled out a bracket! This year’s tournament has had surprisingly few upsets. Some are attributing this outcome to the relatively new rules that allow college athletes to be paid. Seems plausible, incentives matter in everything. It’s got me thinking about the different incentives investors have.

To start with a recent example, last week CoreWeave IPO’d at $40/share in the biggest tech IPO since 2021. The shares struggled in the first few days of trading in a disappointing debut. This wasn’t the first disappointment. Prior to the listing, the company had to downsize the offering size and lower the price to entice investors. Additionally, out of the $1.5B raise, $250M came from an “anchor order” from Nvidia, who is already a major shareholder and has been an integral partner to Coreweave as an investor, supplier, and customer. Nvidia owns equity in the company, they sell GPUs to CoreWeave, and CoreWeave sells services to Nvidia. 

💰 What matters to investors?

What you pay for an investment and what you get from an investment is literally everything that matters to returns. It’s formulaic, a return is computed by dividing the cash flows you get from an investment (including selling it) by the price you paid to acquire it in the first place. The numerator in that equation is uncertain, you don’t know how well a company is going to do in the future when you make an investment. But the denominator is known! You can absolutely know the price you will pay for a share of a company. And the price you pay contains a lot of information. Embedded in that price is some expectation for future growth and cash flows. A higher price implies higher expectations of business performance. Any investment process that ignores the price you pay for an investment is doomed to fail, in my opinion. So prices are important, but not all prices are created equal. Let’s look at the incentives different investors have to understand how reliable (or not) prices can be.

In the Coreweave situation, the fact that Nvidia is an investor, supplier, and customer doesn’t help the investment case for outsiders and is probably partially responsible for the muted debut. As investors look at potential IPOs, they understandably care about the company’s previous valuations and funding rounds. Are those prices reliable indicators? If Nvidia is a true strategic investor, shouldn’t they be willing to invest at a higher price than outsiders because of the strategic importance? Therefore, has the valuation been inflated by this closed loop where the investor is also a key supplier and customer? Investors certainly have a strong incentive to perform well. If an investor can influence the price of their investments, they can influence the calculated performance of their investments too. This happens all the time! It’s not necessarily bad, but it’s an incentive you should understand before making an investment decision.

🔄 Examples of common closed-loop deals

1. VC-backed companies investing in other startups backed by the same VCs

A venture capital (VC) firm may invest in a startup, but then that startup indirectly reinvests in a different company owned by the same VC partners. This can create the illusion of independent success while keeping money circulating within a small, controlled ecosystem.

2. PE buyouts and resales among affiliated funds

Private equity (PE) firms often raise multiple funds, and sometimes they sell companies between their own funds. This allows them to mark their portfolios while moving assets within their own ecosystem.

3. Companies investing in and buying from their own investors

Companies sometimes buy products from their major investors. This creates revenue and growth, but how “real” is that demand? Can you rely on that growth to continue when they have to sell their product to others?

As mentioned above, these inbred deals aren’t necessarily bad. But as an investor, you have to understand these dynamics and make decisions with eyes wide open. With hindsight bias, WeWork and SoftBank’s Vision Fund is a great example of how this can play out poorly.

🧨 When it goes wrong - WeWork and Softbank

SoftBank’s Vision Fund invested aggressively in WeWork, pouring in over $10 billion between 2017 and 2019. At its peak, WeWork’s valuation was marked at $47 billion, despite its financials showing massive losses. Softbank was primarily responsible for this valuation as it kept reinvesting in WeWork at higher and higher valuations, creating a feedback loop.

Additionally, to bolster WeWork’s revenue, SoftBank encouraged or required its other Vision Fund portfolio companies to lease office space from WeWork, which made WeWork’s revenue look better than it otherwise would have.

As WeWork’s failed IPO in 2019 exposed its financial instability, SoftBank again stepped in with a $9.5 billion bailout investment. The bailout didn’t work and WeWork ultimately filed for bankruptcy in 2023.

In some cases, “fake it ‘til you make it” works out in the end. But not this time, artificial valuations driven by artificial revenue didn’t spin up the outside demand that was expected and the company collapsed.

The price you pay for an investment matters for your return, but not all prices may be the result of truly independent market forces. Understanding when that is the case, and what that might mean for you as an investor is key.

Things we’re digging:

• 🏀 Final Four matchups are in, and it’s Florida vs. Auburn and Duke vs. Houston. Let the office bracket trash talk continue!
• 📱 Apple’s iOS 18.4 is here, bringing smarter notifications, expanded language support, and a fresh batch of emojis, including a shovel and a...purple splatter? Would include them here, but I haven't updated yet.