Silicon Valley Bubble

Posted on October 9 by David Laidlaw

Evidence continues to mount that certain sectors of the technology market are experiencing a speculative bubble similar to the one that developed during the late 1990s. A prominent venture capitalist from Silicon Valley, Bill Gurley, reignited this debate during an interview with the Wall Street Journal in mid-September.

Gurley argued that excessive risk taking is apparent given the sheer number of people working for money-losing companies in the technology field. He also argued that the expansion of this behavior is self-reinforcing. Managements at private companies have witnessed large public companies rewarded with higher stock prices for revenue growth without profitability. Therefore, those private companies increased their own rate of cash burn since the financial markets were willing to fund money-losing enterprises without hesitation.

Out of the 100 largest North American-based technology companies, 16 have lost money over the past year. In aggregate, the market is valuing these companies at $160 billion. However, on a combined basis, these entities have lost over $9 billion. A bad quarter or two could make these statistics even more compelling. For instance Amazon supports a market capitalization of almost $150 billion, yet, the company earned less than $200 million over the past year.

Recent initial public offerings provide additional evidence of speculative valuations. Alibaba set a record in its recently completed IPO raising over $20 billion with a market capitalization of roughly $215 billion. Alibaba is profitable, yet the purchasers do not own shares. Alibaba issued securities in a Variable Interest Entity (VIE) based in the Cayman Islands. This VIE has a contractual right to receive profits from Alibaba. Owner’s of VIE securities may have limited legal protections to enforce their property rights. A few years ago, Alibaba divested its interest in its Alipay subsidiary (similar to PayPal) to its managers including the company’s founder, Jack Ma, even though the move prejudiced large investors such as Yahoo and Softbank.

Adventure camera maker GoPro went public earlier this summer and its shares have tripled in value. GoPro now supports a market capitalization that is two-thirds of that carried by Sony even though GoPro’s revenues were only 1.4% of Sony’s over the past four quarters. Apparently, Wall Street’s analysts and exuberant investors believe that GoPro will be able to build a media empire rivaling YouTube with content from their cameras even though GoPro has yet to report any media revenues in its financial results.

Netscape founder and technology guru, Marc Andreesen, also broadcast that current market valuations “WILL NOT LAST” and that many companies burning through their cash would“VAPORIZE.” He closed his Twitter rant with one word: worry. He also indicated that his venture capital company has stopped investing in growth stage companies.

Many current technology entrepreneurs and financiers did not experience the aftermath of the technology bubble when billions of dollars in value disappeared, since they were too young at the time. Tech manias produce many fantastic products and services for consumers and businesses, but prudent investors should look elsewhere to risk their capital.