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This Hedge Fund Has Bizarrely High Valuations on Dropbox and Other Unicorns

Key Speakers At The Brooklyn Beta ConferenceKey Speakers At The Brooklyn Beta Conference
Dropbox Inc. signage is displayed at the Brooklyn Beta conference in the Brooklyn borough of New York, U.S., on Friday, Oct. 12, 2012.Photo by Bloomberg — Getty Images

Hedge funder Christopher Hansen’s Valiant Capital Management has gotten a big boost from its lineage. Hansen is an alumnus of a hedge fund of someone who once worked for Tiger Fund Management’s Julian Robertson—earning Valiant the nickname inside the industry, like a number of other firms, of Tiger Cub, though Valiant is technically a grandcub. But it’s another animal, itself legendary, that could be his undoing—the unicorn.

About one-quarter of the fund is invested in private companies, including seven so-called tech unicorns—companies valued at over $1 billion. The unicorns had helped propel the San Francisco-based Valiant’s returns in recent years, but this year have landed the fund in the red, as a number of blow-ups have caused investors to grow more cautious about the richly valued start-ups. Valiant told investors last month that its main fund is down slightly under 10% through April, according to an individual familiar with the performance. Write-downs on its big portfolio of private investments appear to be a major factor, according to investor documents Fortune has obtained.

But a thorough analysts of Valiant’s documents seems to show that Hansen’s fund may actually be down more than he is letting on. According to the documents, Valiant appears to have failed to fully write down the value of a number of his unicorn holdings. As a result, the fund is valuing those holdings at inflated prices, at least compared with where other similar fund say those investments are now worth. That likely means Valiant performance, even its poor performance, is inflated this year as well.

The Securities and Exchange Commission is concerned with how funds are marking their holdings of the highly valued tech start-ups and whether they may be deceiving their investors. Last last year, the SEC began investigating mutual funds to audit their procedures for valuing the private holdings. In a March speech at Stanford Law School, SEC Chairwoman Mary Jo White said that the SEC was committed to protecting investors in the so-called unicorns no matter how sophisticated or high net worth they are. Hedge funds typically cater to high net worth individuals.

“Nearly all venture valuations are highly subjective,” White said during the March speech. “The concern is whether the prestige associated with reaching a sky high valuation fast drives companies to try to appear more valuable than they actually are.”

Hansen, 47, launched Valiant in 2008 after leaving $5 billion Blue Ridge Capital, one of the storied Tiger cub hedge funds run by the notoriously reclusive John Griffin. The Blue Ridge scion began investing in venture capital in 2009 and scored some big hits with Facebook and Alibaba, which he quickly sold out of with 31% gains in each.

Valiant ramped up its venture investing and now has 23 investments, including big names like Dropbox, Evernote, Pinterest, and Uber, according to its investor documents. The investments are held in a separate side pocket, and investor capital is locked in until Valiant exits the privates, via IPOs or other sales. Valiant doesn’t take performance fees on the privates until that time either.

A big drop in the value of the private tech companies would hurt Valiant more than other hedge funds as it is believed to have more in privates than most of its peers. At leading tech-oriented Tiger Global, for example, privates account for less than 8% of the firm’s $8 billion hedge fund, as it invests in startups in separate private equity funds. Tiger Global was down 21% through March, but only about 10% of the losses are attributable to write downs of its private investments, according to an individual familiar with the fund’s results.

Even by its own numbers, Valiant is having a bad year. The stock market is basically flat for the year. But if Valiant was marking it holdings where other funds are, its performance would be even worse.

Take Dropbox one of the most troubled of Valiant’s big VC holdings. Last year, mutual funds Fidelity and T. Rowe Price began writing down their holdings of Dropbox, which has been struggling to justify its $10 billion valuation. As of the end of 2015, Valiant said it valued its Dropbox stake at $50.4 million, or $18 per share, according to calculations from investor documents.

Others weren’t so charitable. By end of last year, Fidelity had written down Dropbox to $13.50 per share and T. Rowe Price had slashed it to $9.40, nearly down to where Valiant’s purchased the shares at $9.05. If Valiant had valued its Dropbox stake where T. Rowe Price did, the fund would have had an additional $24 million in losses on that stock alone.

“Dropbox has greatly exceeded all of Valiant’s expectations and guidance to date,” Hansen wrote in an investor presentation at the time, though he added that the company has “slightly underperformed on the enterprise side.”

Evernote, a cloud-based note taking and storage app that Valiant said was worth $1.4 billion at year-end, is in even worse shape than Dropbox. Last year, Business Insider wrote a story about the company’s “deep troubles.” Valiant invested in several financing rounds of Evernote, and at the end of December it valued Evernote at $12.56 per share, which was a little above break-even for the hedge fund, documents show. Even so, it may have been too optimistic: T.Rowe Price marked Evernote down to $7.66 at year-end.

While others in the industry are questioning Evernote’s future, Valiant claims that “the company is cementing its leadership position in the space” with 1 million new users each month.

Valiant declined to comment for this article.

It could very well be that the fund has adjusted the value of those holdings and others this year. But according to a source, Valiant had only cut the value of its overall private portfolio by 10%. But you would have expected that group on investments to have tumbled more. T. Rowe, for instance, further cut its price of Dropbox to $7.91 at the end of March, according to the Wall Street Journal. By that measure, Valiant’s investment in the storage company has plunged 56% from where it marked it at the end of last year.

Its Evernote stake, appears to have tumbled as well. T. Rowe now values that company at $6.04, a 52% below where Valiant had valued the stake at the end of 2015.

Valiant uses third-party valuation agent Duff & Phelps to help determine the marks, which it makes quarterly.

Since Valiant is not collecting performance fees on the private states until the companies are sold or go public, Valiant may argue that it doesn’t matter where it values the stakes now as long as it gets them right at the IPO or sale. But that’s not correct. Since the value works into the overall performance of the funds, inflated values can cause the fund to look like it is doing better than it is, giving Hansen the ability to raise more funds, which it has recently started doing. The hedge fund, which told investors it wants to keep assets near $2.5 billion, opened the door this year to new money, hoping to offset redemptions, according to a February Reuters report.

On top of that, while Valiant isn’t collecting performance fee on the private investments, it is collecting its 2% management fee on the value of all the assets in his fund. Inflated valuations of those unicorns will boost what Valiant collects from its management fee.

Valiant still has big gains in Uber and Pinterest, valued at $64 billion and $11 billion respectively. Although Pinterest has been mentioned as a 2016 IPO candidate, Valiant seems to have slightly cooled on the social media company, writing it down 3% during the fourth quarter to $6.97 per share. Funds run by two investment companies Hartford and The Principal have dropped the value of their Pintrest stakes to $6.43 per share.

Overall, Valiant had an annualized gain of 9% since inception through 2015. But if the unicorns keep spearing this tiger, that number is going to get smaller.