I had drinks with one of the $US1 billion “unicorn” CEOs last night, in a trendy Noho bar in London.
He told me he thinks we’re in a tech bubble, and it’s going to end badly for many companies.
Unicorn companies were so-named a few years ago because it was exceedingly rare for a tech startup in private hands to be worth as much as $US1 billion.
But now there are 102 “unicorn” companies. So finding a unicorn CEO to have drinks with isn’t as hard as it used to be.
This fact wasn’t lost on my unicorn CEO. He was very sure that all these unicorns lying around means we’re in a bubble.
I was somewhat shocked to hear this because, normally, when tech founders take vast sums of money from investors, they have a lengthy and convincing explanation of why their company is fundamentally different from everyone else’s and won’t fail when / if the economy runs into trouble.
But my guy thinks it’s all coming to an end sooner rather than later.
Here is the context. In order to believe there is not a bubble, you have to believe the following narrative: Although tech stocks are at an all-time high, and private tech startup valuations are hitting astonishing highs (Uber is valued at $US41 billion!), this is not a bubble. It’s a boom, for sure, and these companies may be temporarily overvalued. But these companies have real revenues, and the economy is shifting in their direction regardless of the underlying economic cycle. i.e., money is moving out of TV and newspapers and into apps regardless of whether there is a recession or growth.
When the recession comes, the “no bubble” people say, some companies will get hurt, just like in a regular recession. But we won’t see the kind of full-scale bonkers collapse that we saw in 2000 and 2008. Back in 2000, the tech sector deflated because companies had gone public with no revenue whatsoever. In 2008, the economy tanked because banks had loaned mortgage money to millions of people who couldn’t pay it back.
This time it’s different, because these new tech companies are real businesses, the “no bubble” people say.
My unicorn, however, has been worrying that it is a bubble for months.
Here are the things he’s really worrying about:
- People have no memory of 2000 or 2008: The dotcom crash was 15 years ago. The mortgage crisis was eight years ago. An entire generation of entrepreneurs under age 30 has no clue what it’s like when everyone runs out of money at once because they were children when it happened last time.
- Interest rates: Central banks currently have interest rates set at zero per cent. That means any investment that returns more than zero looks good right now. When central banks raise those rates, all the marginal business ideas that return just a few per cent in profits will be wiped off the map — because no one will fund them.
- Valuations: Look at Uber, the unicorn says. Its market cap is now bigger than Delta Air Lines, Charles Schwab, Salesforce.com and Kraft Foods. It’s allegedly bigger than the value of the entire global taxi market is is trying to replace. Sure, he says, Uber is a great business and a great company. But $US41 billion? Now? Maybe in a few years time.
- Private valuations not matching public ones: Some private tech startups are now valued greater than those on the public markets, post IPO. This seems … unusual.
- Tech startups offering stock at a discount in order to juice their valuations. Box offered stock at a discount to late investors, a factor that required its valuation to be written higher. About one in six tech startups increases its valuation not because the underlying business is believed to be capable of generating more value but in order to accommodate protections given to preferred investors, The New York Times reported.
- Burn rates: Some tech founders are walking around telling investors not to worry about the fact that they haven’t yet worked out their revenue models. They have a long runway ahead of them while they perfect their products. These founders are banking on the notion that after their current round of funding there will be another round of funding coming along. When your current business model is to raise more funding … that’s bubble talk.
- Too many business models are dependent on “one thing not happening”: In an economy on the upswing, everyone can survive. A rising tide lifts all boats. But some companies seem to be dependent on a certain single factor not happening, such as being unable to raise a new round, being unable to become cash flow positive in the near-term, or being unable to stop competitors raiding your workforce in a downturn (when there is no money to persuade them to stay).
- “Margin compression”: A lot of tech businesses sell things, and because the market is good there isn’t much price competition. My unicorn sees a lot of companies that appear to be dependent on customers paying what they’re told to pay. These companies have yet to experience, or survive, a price war with their rivals.
Of course, like all unicorn CEOs, my unicorn was pretty confident that he’s going to do just fine in a recession, or when the Fed and the ECB start raising interest rates. In fact, he’s looking forward to it, in part because it will wipe away a lot of not-great, second-rung companies who only exist because so many VCs are diversifying their portfolios across so many tech sectors.
But it won’t be pretty, he says. Bubbles burst, and we’re in one.