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Signs That The Silicon Valley Tech Bubble Is About To Burst

Saturday, March 18, 2017 13:00
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18 months ago there was a seemingly limitless number of Silicon Valley future billionaires buying up multi-million dollar homes and renting out lavish pads.  But if demand for excessively priced real estate is any indication of the health of Silicon Valley’s tech industry then all the venture capitalists who have tripped over themselves to invest in the next ‘decacorn’, or startups worth $10s of billions pre-IPO despite burning billions of cash quarterly, should be getting pretty worried right about now.

As the following chart from Zillow points out, home prices in San Francisco stalled about a year ago and rents have followed a similar path.

San Fran

But home prices aren’t the only thing stalling, according to a note from The Guardian, resumes are also starting to flood into Silicon Valley headhunters from recently unemployed software engineers who were let go after their companies failed to attract its required latest round of financing at a ridiculous valuation.

“We’re starting to get a lot of résumés from [software engineers at] companies where the business model isn’t working and they can’t get funding, so they are closing down or cutting back,” said Mark Dinan, a software recruiter based in the Bay Area, who keeps track of companies’ hirings and firings.

These startups are running out of money because VCs are being more discerning about where they place their money, making fewer, bigger bets.

“The number of investments [in the private market] has fallen by about a third, but the amount of capital is around the same,” said Tomasz Tunguz, a venture capitalist at Redpoint, adding that some of the “fast money” from hedge funds and mutual funds had shifted away from the sector.

“It’s been happening for a couple of years. It’s not as easy to raise capital and VCs are demanding better terms,” added Aswath Damodaran, a professor of finance at the Stern School of Business.

Despite the meteoric rise in the stock market over the past several years, venture capitalists have been forced to pull back on new investments partly because of a slowdown in companies going public. Last year was the slowest for US IPOs since the recession, with the amount raised by technology companies falling 60% from 2015.

Tech IPOs

Meanwhile, if SNAP’s IPO is any indicator of how other potential tech IPOs might be expected to perform, then we wouldn’t hold out hope for public investors to save the venture market from their valuation sins.

SNAP

But, a series of “down rounds” – when a company raises funds by selling shares that are valued lower than the last time they raised funds, leading its overall valuation to fall – may imply that there just isn’t a healthy backlog of companies that are IPO-worthy. CB Insights has tracked more than 100 of these down rounds and exits since 2015, including software company Zenefits, mobile app Foursquare and online music streaming service Rdio.

“It used to be that 95% of [investment] rounds were up, now 20% are down,” Tunguz said.

Then there are the so-called “decacorns” – unicorn startups valued at tens of billions of dollars – such as Airbnb, Uber and Palantir – which some believe are overvalued, but it’s hard to tell until they go public and are forced to reveal details of their underlying finances.

Ride-sharing app Uber, for example, has raised more than $16bn and is valued at more than $69bn. That’s more than automotive giants such as General Motors and Ford, despite the company losing $2.2bn last year.

“The interesting question with Uber is how long they can keep as a private company. They are raising capital like a public company without any of the disclosure and consequences of being a public company,” said Damodaran, who believes the company’s value is overinflated and it’s really worth $23bn.

So, how does this moment compare with the time leading up to the dotcom crash?  Here is the take of one Silicon Valley software recruiter:

“I got here in 97 and it was like it is now – incredibly packed, impossible to commute, high apartment costs,” Dinan said.

“We’re seeing overvalued companies, funded based on hopes and dreams and aspirations and not good business models. Companies counting users and eyeballs rather than profits. There are a lot of similarities.”

Another echo of the dotcom era is what Dinan calls “bad habits” such as the allegations of sexual harassment at Uber and human resources startup Zenefits cheating on mandatory compliance training.

“There was a lot of crazy behaviour in the late 1990s, including sexual harassment. It’s a result of there not being discipline,” Dinan said.

“The [dotcom crash] happened very suddenly and without any warning,” Damodaran said. “When it does happen everyone says they saw it coming. If you saw it coming then why didn’t you get out of it?”

Well, when all else fails there’s always the ‘negging’ option to drive valuation…



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