The stock market is at an all-time high. Tech startups with no revenue have billion-dollar valuations. And engineers are demanding Tesla sports cars just to show up at work.
Here’s the evidence that we’re in a new tech bubble, heading for a crash, just like the dot com bust of 1999.
Interest rates are effectively at 0%.
Before we get into specific evidence that the tech sector is inflated, it’s worth restating the macro-economic context: Interest rates are basically at zero and have been for some time. When borrowers are paying close to zero interest on loans, that makes money cheap to get. This chart shows the Fed’s target rate for interest since 1970.
People with money generally have a choice: save it in interest-paying, risk-free bank accounts or invest it in riskier assets that may pay more money over time. When interest is at zero, virtually any other kind of investment is likely to pay more because the risk-free alternative is so lousy. So investment asset bubbles get created. Stocks tend to go up.
The stock market is at a peak, which is exactly what you’d expect in a zero-interest environment.
We’ve had five years of solid growth in stocks. People who have invested in stocks in the last five years now feel very, very rich. What could possibly go wrong?
The market moves up and down, in cycles, as this chart of the S&P 500 stocks shows.
We’re due for a downturn.
In the tech sector specifically, there has been a recent run-up in deal prices.
This chart was published by PriceWaterhouseCoopers, which tracks merger and acquisition activity in the tech sector.
It notes that “software deal volume tripled that of the second quarter.”
The driving force?
High stock prices and corporate giants who are rich with cash and need to invest it, PwC says.
It’s not just tech asset prices that are high. Salaries are high, too.
While unemployment generally may be high, in the tech sector it is very low.
Tech companies, led by Mark Zuckerberg at Facebook, are lobbying Congress to relax immigration rules so they can hire more foreign talent because they believe domestic talent has gotten too scarce and too expensive. It’s driving up wages bills like crazy.
Matt Allen, a tech recruiter at Vertical Move, told me recently:
We’re experiencing first hand greater insanity than the dot-com days when Interwoven Software was pulling out BMW Z3’s for engineers who joined. Instead, we’re seeing sign-on bonuses for individuals five-years out of school in the $US60,000 range. Candidates queuing-up six, eight or more offers and haggling over a few thousand-dollar differences among the offers. Engineers accepting offers and then fifteen minutes before they’re supposed to start on a Monday, emailing (not calling) to explain they found something better elsewhere.
That suggests that wages in tech are in a bubble.
Want an example?
Twitter svp/technology Chris Fry got a $US10 million pay packet. He only joined the company last year.
Fry is paid more in annual compensation that Jack Dorsey, the chairman of Twitter’s board and the founder of the company.
That’s how much the price of wages has risen in the tech world. Fry is not a one-off event. Facebook’s vp/engineering, Mike Schroepfer, got $US24.4 million in 2011, Reuters noted:
One start-up offered a coveted engineer a year’s lease on a Tesla sedan, which costs in the neighbourhood of $US1,000 a month, said venture capitalist Venky Ganesan. He declined to identify the company, which his firm has invested in.
It’s not just wages that are expensive. Company valuations are rising too.
Supercell, the game company, just raised $US1.5 billion in new funding at a valuation of $US3 billion. Supercell has real revenue — $US178 million in Q1 alone.
But you’ve got to question the logic of the people doing the deal: Investor Masayoshi Son, the founder of Softbank, believes he has a “300-year vision” of the future.
Even the CEO of Supercell thought he was joking when he first heard about it.
Companies with broken business models are highly valued.
Fab.com, the design retailer, recently raised $US165 million in new investment this year, for a total of $US336 million in all venture funding. It did so despite laying off 440 employees after deciding that the flash sales model — in which customers are asked to suddenly purchase a daily deal — doesn’t work.
It was Fab’s second business model “pivot” — the company started life as a gay community site.
We’re not saying Fab is going out of business. We’re saying that Fab’s backers have been fabulously generous.
Companies without meaningful revenue are highly valued.
Pinterest just raised $US225 million in new investment funding, a stake that values the company at $US3.8 billion.
That valuation is fictional, of course. It’s based on the notion that the company could be sold or go public at that price. That price is 10 times what investors have actually plowed into the company.
To be clear, Pinterest is showing every sign of turning into a great company. It has already solidified a role for itself as a key referrer of online retail and e-commerce traffic.
But still, this is a company that currently is rumoured to make only between $US9 million and $US45 million in revenue.
Companies with no revenue at all are highly valued.
Snapchat is rumoured to be raising a new round of funding that values the company at $US3.6 billion on paper.
This company has zero revenues.
And it’s not easy to see how it might make money: It’s defining product deletes itself after just a few seconds.
The last time we saw companies with no revenue receiving high valuations from investors was right before the 1999/2000 dot com crash.
Yahoo is again paying top dollar for companies with no meaningful revenue, just like it did in 1999.
Yahoo recently paid $US1.1 billion to acquire Tumblr, the social blog network. Tumblr’s revenues are so small Yahoo isn’t required to mention them in its financial statements — they just don’t move the needle.
Again, to be clear, Tumblr is actually an excellent product with 50 million users. But for Yahoo to make money on this deal, Tumblr will have to generate profits after sales of greater than $US1.1 billion.
My sources tell me that with the right adtech, Tumblr could generate several hundred million in ad sales revenue over the years. But they don’t believe Yahoo will ever get its money back on the deal.
This is significant because Yahoo does not have a good track record when it comes to buying in a bubble. In 1999, right before the last tech crash, it bought Broadcast.com for $US5.9 billion in stock and GeoCities for $US3.57 billion. Neither business had meaningful revenue and both have since been shuttered.
Companies are making dumb decisions: This startup chose beef jerky over a 401 (k) plan.
Hunter Walk, an entrepreneur who recently co-founded an early-phase venture firm called Homebrew, told me about a startup where he’d previously worked. The company had needed to figure out whether to spend its limited budget on beef jerky to keep around the office or 401k plans for the staff. “We put it to a vote: ‘Do you want a 401k or jerky?’ ” he explained. “The vote was unanimously for jerky. The thought was that well-fed developers could create value better than the stock market.”
Serious investors are beginning to suspect a tech bubble has formed, and that a crash is coming.
Art Cashin, the the director of floor operations for UBS Financial Services, has been around the block. He recently worried that he he was seeing things that reminded him of 1999:
“I do worry a little bit that we’re beginning to hear things that are reminiscent of the 1999-2000 period — the number of hits, the number of eyeballs,” said Cashin, …
“I think if we hold to the old tried-and-true — how many dollars are coming in — then we might be better served,” Cashin said. “But people are extrapolating, in some way, in a manner similar to the way they did in 1999-2000.”
“For an old fogey like me,” the trend of extrapolating future earnings based on users and viewers “gets the warning flags flying,” Cashin said.
Andreessen Horowitz is pulling up the ladder.
Andreessen Horowitz is is the sine qua non of Silicon Valley investor groups. It had stakes in Facebook, Twitter, Pinterest, Groupon and Zynga.
Now it is saying it will no longer invest in early stage consumer-oriented startups.
Andreessen is interested more in later stage and business-to-business-oriented companies. Companies with actual prospects of real revenue, in other words.
This, arguably, is the kind of “flight to quality” you often see when asset prices and stocks start falling. What does Andreessen know that we don’t?
One of the most legendary tech investors, Tim Draper, thinks we’re at the end of the curve.
Timothy Draper is the founder of Draper Fisher Jurvetson, a venture capital outfit that has invested in dozens of tech startups. He’s been around since the days when Hotmail was the big new thing.
He recently told The New Yorker that he believed tech venture capital may have reached the top of its cycle:
“I’ll draw you the cycle,” he said, taking my notepad and pen. He scrawled a large zigzag across the page. “This is a weird shark’s tooth that I kind of came up with. We’ll call it the Emotional Market of Venture Capital, or the Draper Wave.” He labelled all the valleys of the zigzag with the approximate years of low markets and recessions: 1957, 1968, 1974, 1983, and on. The lower teeth he labelled alternately “PE,” for private equity, and “VC,” for venture capital.
Draper’s theory is that venture booms always follow private-equity crashes. “After a recession, people lose their jobs, and start thinking, Well, I can do better than they did. Why don’t I start a company? So then they start companies, and interesting things start happening, and then there’s a boom.”
Eventually, though, venture capitalists get “sloppy” — they assume that anything they touch will turn to gold — and the venture market crashes. Then private-equity people streamline the system, and the cycle starts again.
Right now, Draper suggested, we’re on a venture-market upswing. He circled the last zigzag on his diagram: the line rose and then abruptly ended.
Let’s hope he’s wrong.
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