The Death Of Hopium
As many readers know, I spent 13 years living and working in Silicon Valley before partnering up with Chris to start Peak Prosperity.
I got my MBA at Stanford in 1999 when the dot-com bubble was at its zenith, and worked for both a VC-funded start-up as well as one of the biggest Internet juggernauts (Yahoo!). I lived in Palo Alto, the central core of the tech scene.
As a result, I have a pretty good read on how Silicon Valley works. Many of the folks I worked and went to school with are now in leadership positions at the big operating companies, VC firms and hedge funds in that ecosystem -- so I have personal knowledge of who's making the decisions.
And it's no secret that I think things have degenerated into a steaming pile of hucksterism.
The "engine of our economy", the "cradle of innovation", the "land of tomorrow" -- whatever breathless hyperbole the fawning media is using this week -- is a sham. Silicon Valley has become a factory of hype, funneling gobs of early-stage capital into whatever half-credible concepts it can think of, and then pimping the artificially-inflated initial results of those tarted-up ventures to whichever "greater fool" is willing to acquire it or buy its IPO. Let that idiot figure out if it will ever turn a profit...
Like the too-cozy relationship between DC and Wall Street, I see a similar one between Wall Street and the Tech sector. They collude to pump out as many opportunities as they can -- private placements, acquisitions, IPOs, secondary offerings -- to cash out the insiders and foist the long-term financial risk onto the "dumb money" (pension funds, foreign capital, retail investors, corporations desperate to enter the "digital age"). The dreams of 'changing the world' or revolutionizing lives by making great products have taken a distant back seat to the drive to have as lucrative an "exit" as possible. If that exit requires selling junk to unassuming buyers, so be it.
As with Wall Street in general, the Tech story has been driven by ferocious and cheap liquidity. The Fed and the other major world central banks pumped trillions and trillions of freshly-printed money into the system starting in 2008, and it largely went into the hands of the major financial institutions and the top 1%. All that money has to go somewhere, and the high-potential rewards offered by tech ventures is a really attractive magnet for it. Coupling that with the administration's "Don't worry, technology will save us!" meme to calm market jitters, and the media's amplification of that message in desperate hopes it will come true, it should come as little surprise that money has been lining up to enter Silicon Valley over the past 6 years. There literally have not been enough ventures to invest in to soak up the supply of capital sloshing around Silicon Valley.
This, of course, has led to the stupidly fast pace at which we've entered Tech Bubble 3.0. Facebook, LinkedIn, Twitter, etc went public several years back to astronomical valuations given their (lack of) profits. Since then, a herd of "unicorns" -- start-up companies with no profits but $multi-billion valuations -- stampeded onto the scene. A new mythos of all-knowing visionaries (Musk, Kalanick, Dorsey, etc) emerged to replace the previous generation of "god like" sages (like Jobs, Schmidt, Bezos). A sense of hubris and entitlement returned to the rank-and-file employees working within the over-designed and over-perked corporate HQ-plexes that pepper the 101 corridor. Real estate prices in San Francisco and surrounding counties blew through the previous heights set in 2007, and housing affordability there is now at a record low. And a new dynamic this time, capital flooding in from Asia (mostly China and India), has provided the rocket fuel at the margin for prices of both homes and companies to soar.
How shockingly little we learn from history.
Not ancient history, mind you. We saw this same movie play out just 7 years ago in 2008. And that took place 7 short years after the initial dot-com bubble burst in 2001.
As they say, "Those who cannot remember the past are condemned to repeat it". The Ponzi-like party that the current crop of Technorati are enjoying cannot last forever. It can only continue as long as incoming capital flows exceed demand, and someone is willing to bid higher than the seller's basis.
Well, there's growing evidence that the end is nigh. (Finally! shout those of us living out here with a front row seat to the insanity).
As with all bubbles -- which are a product of mass psychology -- they resist all influence of logic and fundamentals until perception shifts. It's at that moment, when the veil of hopium is cleared from the public's eyes, that the fawning crowd can suddenly see that the emperor is actually naked.
And we are finally seeing the initial signs that sentiment is beginning to shift.
First, there's the obvious: several companies that were Tech's proudest 'darlings' just a year ago are now looking a lot uglier. For instance, last month, Twitter's stock price was down nearly 65% percent from its year-ago high, and had dropped below its IPO price -- a shameful milestone for the former high-flier. It's CEO, Dick Costello, was ignominiously dumped; and after a much-criticized search for a replacement, the new CEO, Jack Dorsey, announced today that the company will be laying off 8% of it workforce, many of them engineers. Those who work in Silicon Valley will confirm that an engineering job has had about the same job security as academic tenure up to now. The fact that any company in the Bay Area, but especially a tech-bellwether like Twitter, is firing engineers en masse is a big discordant departure from the status quo here in Tech-land. If the engineers are getting cut, it's a sign that the senior executives are very, very worried.
But perception and sentiment aren't just about the numbers; they're about the vibe, the "feel" of things. What's being talked about in the hallways, at the trendy coffee bar, or voiced behind conference room doors. And the tenor of that vibe has suddenly become a lot more off-key.
During a recent gauntlet of industry conferences held in the Bay Area by the likes of Fortune, Re/code and Vanity Fair, the speakers gave voice to a nervousness that's been absent during the past half-decade of bulletproof optimism:
We talked to a lot of these execs, as well as the quieter folks behind the scenes, at the events and the parties afterward, and a common theme shone through: Everybody agrees we're in a tech bubble.
At the Code/Mobile conference in Half Moon Bay, there was a lot of chatter about "on-demand" companies such as Uber, Postmates, and Instacart. These companies sprung up over the last few years to provide conveniences at the touch of a smartphone button to busy professionals with disposable income.
But investors are worried that these companies have been subsidized by easy VC money for too long. In many cases, their customer and usage numbers are going up because they're using VC money to expand into new cities, but customer-acquisition costs remain high and many of them are bleeding money. Worse, mature markets like San Francisco and New York are starting to see some scary, weak customer-adoption numbers, which bodes poorly for these companies as they expand into other regions.
Basically the theory is that you can only sell a dollar for $0.75 for so long until you run out of money. That's going to happen at some point, and some investors believe a lot of these companies will vaporize.
The invading gloom has been noticed by journalist Dan Primack, who has covered the venture capital beat for years:
The party isn’t entirely over, but you can hear someone shouting “last call.”
Every couple of months I leave my small Massachusetts town — where most people still shop for their own groceries and drive their own cars — and head for the Bay Area. Suddenly, all of my cynicism and bubble worries are drowned out by the kind of unfettered optimism that only $1 billion valuations (on $0.00 earnings) can buy.
But not today. Not this time.
Since landing in San Francisco on Wednesday, I’ve met with an assortment of senior venture capitalists, bankers, entrepreneurs and crossover investors. All of them have, in one way or another, been involved with so-called ‘unicorn’ companies. As in the past, they are nearly unanimous in sentiment. The difference now is that their sentiment is fear.
The past several years of raising too much, too high, too soon has run smack into a much more conservative investor ethos. Later-stage tech startups can still raise growth equity — and still lots of it — but not necessarily at the terms they were receiving just two months ago.
“This shift is only five or six weeks old, so most companies haven’t felt it yet,” a senior tech banker explains. “But I know of many companies who raised money at $1 billion valuations last year that are now being told that, to raise money now, they need to take around $700 million or $800 million. Probably with some serious structure that protects investors, like ratchets, on top of it.”
The reality is that record-high private market valuations have been driven by two things: Wall Street’s lust for growth at all costs, and relatively high tech multiples in the public markets (and, more specifically, applying the former to the latter). But a variety of macro economics factors (China, the inscrutable Fed, etc.) have cut public equity prices and moved the spotlight to unit economics, which means some pretty large biz model disruption for the disruptors.
Moreover, many of the crossover investors fueling these big deals were playing primarily for IPO optionality, and the successful VC-backed tech IPO has become few and far between. No longer are they willing to have terms dictated to them when the endgame seems so much less certain, and particularly not based on ambitious internal growth projections that would never be provided to the public in filings or on earnings calls.
Nick Bilton, technology and business columnist for The New York Times takes it even further, decrying current valuations as "out of whack" and advising it's time for tech investors to "put your money in your mattress" to protect it from the coming carnage:
So sentiment is shifting, but it's early on in the process. Like a ball tossed in the air that reaches its apex, it reverses direction slowly at first, but then speeds up with rapid acceleration.
We are likely to see one of the great confidence-supporting memes of the past 7 years -- the unstoppable virility of our Tech sector as a jobs and capital gains engine -- unravel over the next year and a half. This in-turn will remove one more of the dwindling number of pillars supporting the 'master plan' our central planners have been claiming is necessary for stabilizing the global economy.
Once the public's faith in Tech is shaken, how far behind will its faith in the Fed follow? How quickly will tolerance of further taxpayer-funded welfare programs for our big banks evaporate? Or of the cronyist revolving door between DC and Wall Street? Or of more policies that expand farther the wealth gap between the 0.1% and everyone else?
Change happens quickly once beliefs shift. As we continually advise here, make your preparations now, in advance, while supplies are still abundant and affordable.
Oh, and develop a taste now for unicorn meat. There's going to be a heck of a sale on it over the next few years.