Tech froth has some investors talking bubble—and unicorns
A tech entrepreneur recently was celebrating his good fortune at a penthouse party overlooking the Las Vegas Strip, but the scene could well have unfolded in New York, San Francisco or any other city where entrepreneurs are feeling the glow of success.
"It's spectacular, befitting this conference and the people here," gushed Joe Liebke, CEO of Villaway, a luxury-vacation company that hosted a party during the recent tech-centric Collision Conference here. "Enjoy it."
Enjoy, the tech industry has. A dizzying mix of bold ideas and lavish investments has catapulted dozens of privately held start-ups to unicorn status, defined as having market valuations of at least $1 billion often without soaring revenues to match. Social-sharing site Pinterest has soared to $11 billion. Ride-hailing company Uber is now worth a staggering $50 billion.
How long can the party last?
While not all tech sector veterans invoke the catastrophic dot-com bubble of 2000, many are nonetheless concerned a correction of sorts is imminent, according to interviews with more than a dozen VCs and executives.
"I do think you'll see some dead unicorns this year," venture stalwart Bill Gurley of Benchmark Capital told a crowd at South by Southwest a few months ago. That sentiment was echoed weeks later by Sequoia partner Michael Moritz, who declared: "A considerable number of unicorns will become extinct."
The belief is that revenue isn't growing fast enough to justify these bloated values as companies rapidly burn through cash. The fear is that wounded unicorns will trip up the trumped-up value of many other tech start-ups. And the reality is that when social-media titans Twitter (TWTR), LinkedIn (LNKD) and Yelp (YELP) recently posted middling quarterly results, it served only to fuel the unease.
The pitfalls of an inflated market value is highlighted by the cautionary tale of Box (BOX), which went public in January. The cloud-storage provider had a valuation of about $2.4 billion when it raised a VC investment of $150 million in July 2014. But by the time it went public, its valuation had sunk to $1.7 billion.
"You can't smell the soap when you are inside the bubble too long," says David Chao, co-founder and general partner at DCM Ventures, told USA TODAY. "Everyone in the industry knows it's a bubble but just wants to believe otherwise. (It's) human psychology. This cycle of the tech bubble will last until smartphone penetration tapers off worldwide in about 18 months."
Tech maverick Mark Cuban doesn't mince words. "I have absolutely not (sic) doubt in my mind that most of these individual Angels and crowd funders are currently under water in their investments, absolutely none," he wrote in a blog post titled, "Why This Tech Bubble Is Worse Than the Tech Bubble of 2000."
He continued, "There is ZERO liquidity for any of those investments. None. Zero. Zip. ... The only thing worse than a market with collapsing valuations is a market with no valuations and no liquidity."
HOW 2015 ISN'T 2000
Such dire warnings aside, there are clear distinctions between the two eras, according to many VCs and tech executives who have lived through both and spoke to USA TODAY for this article. Technology, for one, is more deeply entrenched in the U.S. economy and less susceptible to a cataclysmic crash.
Former Apple CEO John Sculley says a changing audience — Millennials weaned on mobile devices and the share economy, for example — considerably alters today's tech landscape.
"A lot of it is timing," he says, pointing out similarities between failed dot-com delivery plays such as Webvan and today's more successful iterations such as Google, which runs Google Express. Today's start-ups are valued higher, but they are "real businesses" with proven financial models, he says.
Although there is more private capital chasing deals than ever before, "I wouldn't call it a bubble," says Kevin Iudicello, managing director of Pagemill Partners. "Most of the companies are in good shape, and there is no question they will grow — but at that valuation?"
That depends on whether private investors continue to overreact to the unicorn phenomenon, providing late, gigantic cash infusions in the hope of getting equity in the next Google or Facebook.
"There is a migration of capital from public markets to private," says Scott Kupor, managing partner at Andreessen Horowitz. "We just haven't seen these billion-dollar valuations overnight. But if you think of it as substitution of relatively fewer IPOs, concentration of money has shifted."
"If it's a bubble, it's the strangest bubble we've seen by all dimensions," Kupor says.
Research provided by Andreessen Horowitz shows just how much more super-heated the investment waters were in 2000, with far more money chasing considerably more tenuous business ventures that seemed eager to become IPOs at all costs. In 1999-2000, there were 632 tech IPOs, compared with 510 in the 13 subsequent years. In 2014, there were 49 public offerings, and just four so far this year.
Companies that went public last year had been around an average of 11 years. In 1999-2000, most companies rushed into their IPO after just 4½ years. On the money side, $33 billion was raised in venture capital in 2014, compared with $50 billion in 1999 and $105 billion in 2000.
Companies are staying private longer for a variety of reasons: to avoid the public market meltdown that befell their predecessors at the turn of the 21st century; structural changes in capital markets; and the rise of the activist shareholder.
But while aggregating an audience through "eyeballs" (customers) was the main goal 15 years ago, most of the unicorns today — think Uber and Airbnb — are built around real solutions, says Justin Kitch of Curious.com, formerly Homestead. He had been courted by bankers and filed to take Homestead Technologies public just before the 2000 bubble popped. Instead, he kept Homestead private for seven years, until it was sold to Intuit for $170 million in 2007.
"It used to be growth at all costs," Kitch says. "What is happening today is once someone gets a high value, it is passed along to similar companies, regardless of the company. Uber is a real business, in a transformative industry. It is not a Webvan."
THIS TIME 'PUBLIC MARKETS HAVE LEARNED'
Trinity Ventures partner Patricia Nakache has worked as a venture capitalist for more than 15 years and witnessed the boom and bust of the dot-com bubble and great recession. Having carved out a name for herself as an investor in mobile commerce, she is seeing trends as an investor that mirror those of the late 1990s — particularly around the way entrepreneurs manage their relationship with the VC world.
Despite these similarities, the differences are notable. In 2000, the bubble extended to public markets, but this time it is concentrated in growth equity of VC, especially those that raised $1 billion via mega-rounds. "It's like a temperature inversion, but it is more pronounced," she says. "We have a localized bubble. The public markets have learned."
In fact, "the public market is more rational than the private sector, which is overpaying in later rounds," says Joe Horowitz, managing general partner at Icon Ventures. "They have been set up for disappointment."
The escalated valuations are emblematic of a tech-heavy Nasdaq market, which topped 5,000 points for the first time in 15 years earlier this year, and stratospheric market valuations for publicly traded companies such as Apple, Microsoft, Google and Facebook.
But those companies are established, pumping out profits in the billions of dollars.
Burn rates, the amount of cash companies are losing every month to operate, are spinning out of control, Gurley and others contend. Start-ups are spending at a rate far out-stripping revenue in attempts to drive growth.
There is also the possibility of an X-factor: unexpected events in Middle East or China that roil the market.
The real bubble is in bonds, says Peter Thiel, a PayPal co-founder and early investor in Facebook. "Central bankers have intervened to drive up prices, and that won't last forever," he says. "There are overvalued companies today — just like there are at all times — but the best companies are still seriously undervalued."
Thiel says it's important to note that those tech companies that did come through the bubble intact are among the biggest companies on the planet.
"If you look back, survivors like Amazon and Google are among the most valuable companies in existence today," he says. "It was way more important to pick the right companies than to predict the crash."