Benedict Evans, the respected tech analyst at the big Silicon Valley venture capital firm Andreessen Horowitz, just published a fascinating dissection of the current state of tech investing which concludes that tech is not in a bubble because “it’s differentthis time.”
Basically, Evans says, while some measures of tech investing clearly show a boom, a whole bunch of important indicators are nowhere near their 1999 dot com bubble peaks. You can read his slideshow here.
The in-joke in Evans’ presentation is that one of the most infamous anecdotal indicators that you’re in a bubble is when people start rationalising the bubble by saying “it’s different this time” or “this time it’s different.” Evans isn’t literally saying “it’s different this time.” Rather, as his deck says, “it’s always different!”
Nonetheless, for those of us on tech bubble watch, you can argue that Evan’s presentation provides as much evidence for the bubble as it does against. I have three issues with the deck:
- Whenever someone says “it’s different this time” during a massive boom, it’s scary (even if they’re doing it in a sly, knowing way).
- Evans’ data shows that the run-up in tech valuations is concentrated in a much smaller number of hands than it was in 1999. Back then, it was IPOs on the public markets, and anyone could buy the stock. Now, it is privately traded equity — which is much less liquid than regular stock, and concentrated in the hands of VC firms and their bank partners. So we’re looking at huge valuations in a largely illiquid market, where the underlying assets are companies that haven’t quite figured out whether they can actually turn a profit. What could possibly go wrong?
- Evans doesn’t address the low interest rate environment, which most people agree is the underlying cause of the tech boom. Those rates are about to get reversed when central banks start raising rates to stave off inflation.
First, as a note from Credit Suisse said last week, one of the signs of a bubble is when serious people start arguing that there has been some sort of paradigm shift that makes it different this time. The Barron’s contra-indicator is flashing the same way, too.
At a facile level, that is literally what Evans’ presentation says: Tech IPOs are at a much smaller level than they were in the 1999 bubble because companies are staying private, taking longer, later rounds of investment, and the returns on those investments are staying private, too. (Uber is the ur-example of this — it has a $US41 billion valuation after taking 10 rounds of investment totalling $US5.9 billion.) This is the new funding paradigm for tech startups, although Evans does not use that term.
To be clear, this is not Evans’ argument. It is my interpretation of his argument, and I suspect he will disagree with the way I have restated it. But still, a cynic can now say that we have a noted analyst in the field saying there is no bubble because the economics of tech are in a new paradigm and “this time it’s different.”
Those are mere optics, but not they’re not good optics.
The interest rate question is much more serious. Central banks currently have interest rates set at zero per cent. That means any investment that returns more than zero looks good right now. For investors, cash in the bank at 0% interest has been a waste of money. So money has poured into tech startups via venture capital firms like Andreessen Horowitz. Any startup that can return greater than zero looks valuable in this environment. When the US Federal reserve, the ECB and the Bank of England 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.
That big incoming tidal wave of tech investment money, which started in 2002, may suddenly disappear. It looks like this, according to PwC:
After all, why take risks in tech if the bank suddenly starts paying interest on cash, and governments and corporations start offering even more interest on bonds as a result?
The corollary of this is what happens to tech valuations if the funding environment moderates downward. This is what Evans says the funding environment looks like now:
Clearly, a funding peak was reached in 2014 that was bigger than the 2000 dot com crash. But, Evans argues, that money has simply shifted from IPOs to private equity investments:
Again, note the 2014 peak is bigger than the one before the 2000 crash.
The thing with private equity is that it is difficult to sell. You can’t just call up a broker like Fidelity or Hargreaves Lansdown and yell “sell!” down the phone. You have to know someone else who wants to buy it from you in a private transaction. It involves lawyers. It is usually easier to sell a house than to sell private equity privately.
So that big wave of money, that big runup since 2000, has gone into a largely illiquid set of investments.
As the world found out in 2007, when mortgage-backed securities suddenly became illiquid because no one wanted to buy them, that is a pretty good way to structure a market so that it will be more likely to crash.
And that’s why I worry that the insiders who think tech is in a bubble are actually the ones who are right.
One final note. Just to give Evans the proper level of credit — and to demonstrate that his analysis isn’t unreasonable — here is that PwC data on tech funding deals with a longer timeframe than the one I showed above. You can see that, in fact, we aren’t yet at the height we reached in 2000. But we’re getting there …