Looking for signs of a new tech bubble
John Backus thinks the public pays too much attention to unicorns, and he’s not referring to the legendary animal.
The founder of venture capital firm New Atlantic Ventures in Reston, Va., is talking about start-up tech firms that are worth more than $1 billion and haven’t even gone public yet. They’re known in the tech business as unicorns for their supposed rarity.
Start-ups such as Snapchat Inc. in Venice and Uber Technologies Inc. in San Francisco have higher values than many Fortune 500 companies, but Backus said a few high-valued start-ups represent, at most, a “bit of a valuation bubble” among essentially sound businesses.
Plus, the entire venture capital business supporting the tech sector represents such a small slice of the financial landscape, he said, that even a total collapse wouldn’t harm the broader economy as it did when the tech bubble of 2000 burst.
“We’re over-focused as a country on unicorns,” he said. “Even if we [venture capitalists] were totally stupid and it all went to zero, it wouldn’t really move the needle.”
The rise of a new class of American corporation — start-ups with outrageously high values — and an influx of venture capital money have stoked fears about whether an exuberant tech sector is overheating once again.
Shares of publicly traded technology companies are up nearly 13.5% in the last year through Friday, easily surpassing the broader Standard & Poor’s 500 Index, which gained 7.7% in the period, according to FactSet Research Systems Inc.
Meanwhile, private markets continue to provide anecdotal evidence of even more dramatic gains. Uber’s worth, for instance, jumped 119% in six months to $40 billion in December from $18.2 billion last June, according to Dow Jones Venture Source.
And the industry’s latest initial public offering tended to justify the high private values. Wearable tech firm Fitbit Inc. in San Francisco started trading Thursday, and the stock soared more than 50% above its $20 IPO price to $32.50 by Friday’s close, valuing the company at $6.5 billion.
Even so, some believe a bubble is brewing in the private markets, at least.
“When almost everyone who invests in an asset class should write their investment down to zero the day after, that’s a bubble,” said Mark Cuban, who made his fortune in the dot-com era with broadcast.com.
New investments into venture capital funds jumped to $30 billion last year from $17.7 billion a year earlier, according to the National Venture Capital Assn., a Washington trade group.
Investments by venture firms into start-ups hit $49.3 billion last year, up from $30.1 billion in 2013. Most of the dollars have been flowing to the biggest start-ups, including the so-called decacorns worth $10 billion or more, according to Venture Source.
Besides Uber, they include video messaging firm Snapchat, worth $16 billion by its last financing round, and lodging company Airbnb Inc. in San Francisco, valued at $13 billion. Financing rounds now underway will most likely send values of such companies higher.
In all, the venture capital industry had $156 billion under management at the end of last year, compared with $143 billion in 1999, the year before the dot-com crash.
A big worry for skeptics of the private market is its very privacy. Unlike public companies, private firms are not required to disclose financial information, leaving the public to assess values based only on whatever information the companies choose to disclose or leak into public view.
Critics of the industry argue that such opacity is dangerous because business models are untested by, and invisible to, public markets. Cuban said that at some point, sky-high valuations can lead to private companies playing financial games, such as granting additional concessions to new investors in return for increasingly high headline valuations and creating an illusion of value.
“Everyone has one or two ‘real companies’ with real revenue and even earnings, just like there were real companies in the tech bubble,” Cuban said.
“The issue is this: If you raise [money] at too high a valuation, and your business is not growing quickly or you don’t hit the benchmarks you promised investors, then you have to play games with future investors,” he said.
“Each successive VC takes additional rights from the earlier investors. The early ones agree because they know that if they don’t, the company dies.”
Cuban concedes that even if risks are growing in the private markets — and many believe they remain small — the spillover effects to broader markets are likely to be contained.
For one thing, stocks of publicly traded technology companies are trading nowhere near danger levels, said Scott Kessler, a technology analyst at SP Capital IQ. He noted that tech company shares are currently priced at 16.8 times projected earnings, lower than the broader market, which is trading at about 18 times.
“The conversation is really a non-starter in [publicly] listed tech, especially mature tech where we are focused,” echoed Tushar Yadava, iShares investment strategist at New York’s BlackRock Inc. “Mature tech is one of the cheapest sectors in the market.”
Venture capital firm Andreessen Horowitz made an Internet splash last week with a 53-screen slide show arguing against the existence of a tech bubble today, public or private.
It noted, for instance, that overall tech investment was only 2.6% of gross domestic product last year, compared to 10.8% in 1999. Meanwhile, the online market has exploded, with e-commerce revenue at $304 billion last year compared to $12 billion in 1999.
New Atlantic’s Backus said that the rise of unicorns and other start-ups represents a fundamental shift in the way companies are funded, not a bubble.
With venture capital funding plentiful, he said, founders and investors are keeping companies private longer and letting them grow larger to reap much of the gains in value that used to go to public shareholders after initial public offerings.
“What’s changed is the relationship between public and private markets,” Backus said. “Private companies are staying private because they can.”
Indeed, while venture funding is rising, tech-related initial public offerings are down 47.4% this year through June 10 to just nine, compared with 24 during the same period last year, according to mergermarket.com.
With the public markets on the sidelines, Steven N. Kaplan, a professor of entrepreneurship at the University of Chicago, said risks in the private market remain largely confined to the investors themselves.
FOR THE RECORD
June 22, 3:10 p.m.: An earlier version of this article misidentified University of Chicago professor Steven N. Kaplan as Steven N. Booth.
“Valuations are frothy. I would not be surprised to see a number of unicorns decline in value,” he said. “The risks are not comparable to those in the tech boom of 2000, at least not yet. That could change if investment continues or picks up.
“You can think of today,” he said, “as looking more like 1998 than like 2000.”