Long term investors should not be afraid of the mini-bust in tech

Let’s not kid ourselves: the tech industry is in a bubble. Every startup claims to be “changing the world” or “disrupting an industry”. But these are all buzzwords that few companies will live up to. Yes, it’s true that many of these companies offer great products. But how many will ever turn a profit? Few.
So when the next recession and bear market comes, most of these tech companies will go bankrupt. A great product is not enough. A business needs to make profits in order to survive. Valuable companies go bankrupt in recessions not because they’re “worthless” but because they have negative cashflow, cannot meet operating expenses, and cannot raise funding in a tough recessionary environment.
The current tech bubble is in some ways worse than the tech bubble of the 1990s. The valuations of some startups are staggering (tens of billions), even though many of these companies are years away from making a profit. Taking venture capital funding today is akin to going public in the 1990s because companies have realized that VC’s are much more liberal with throwing around money. For example, Theranos claimed to be “revolutionizing the medical industry”. Valued at $9 billion without any meaningful revenue, it turned out that the company was a complete fraud. Fling’s founder (a sexting app) blew threw $21 million on parties and other extravagant expenses before shuttering its doors. Uber is valued at $50-60 billion despite losing $6 billion on $20 billion of revenue.
There has been a decrease in venture capital funding since late-2015. In the past several months, VC funding has declined by a third! This rapid decline has made the doomsayers proclaim “the tech bubble has popped! Run for the hills!” They’re wrong.

What’s really going on

There has been a divergence in the tech industry. Venture capitalists aren’t turning away from funding startups altogether. Instead, they’re becoming more selective about the companies they back.

  1. From 2011-2015, it seemed as if any brand new startup with a shiny new idea could raise $1-$10 million in a series A! “Forget about the product and forget about the revenues. Just focus on the idea. This company might be the next Facebook!”
  2. Venture capitalists aren’t so stupid anymore. Part of their renewed caution is due to slowing gains in the U.S. stock market. The stock market soared from 2011-2015, while its gains since 2015 have been more muted. In addition, interest rates are on the rise and the Federal Reserve has stopped flooding the world with liquidity via quantitative easing.
  3. Instead, VC’s are looking for companies that have viable products (or at least a minimum viable product that’s almost done) and ideally have some revenues. They are no longer throwing money around blindly.

In other words, this is a soft-landing. There is no “crash” in venture capital funding.

What happened in the 1990s

The recent slowdown in VC funding is just that – nothing more than a slowdown. People forget that the 1990s tech bubble came in waves! In between these multiple waves, tech funding via IPO’s dried up for short periods of time.

  1. The first wave (pre 1995) involved software makers like Microsoft and Oracle.
  2. Then there was a slowdown in 1994.
  3. Then there was another surge in tech IPO’s from 1995-1996. This was exemplified by the earliest internet companies like Netscape.
  4. Then there was a half year lull in early 1997.
  5. Then tech surged again from May 1997-July 1998.
  6. Then the tech IPO window closed in the 2nd half of 1998.
  7. Then tech IPO’s charged out of the gates one last time in 1999. This was exemplified by companies like Webvan, which was an online grocery store.

As you can see, the dot-com bubble did not charge from beginning to end in one straight line. There were multiple hiccups along the way. Likewise, the current slowdown in tech is merely a lull in the current bubble.

The bottom line

Yes, tech is in a bubble. And yes, this bubble will burst in a few years. But it will not burst right now. As long as the bull market in U.S. stocks continues, this tech bubble cannot burst. And our model states that this bull market is not over yet. It most likely has at least 2-3 more years left.

2 comments add yours

  1. This post brought back memories of a company called Sun Microsystems who went belly up in 2010. In the mid 80’s that had moved into a town I used to live, Burlington MA. They built this massive facility which looked like a college campus, builders couldn’t build homes fast enough, and real estate shot up. Then after the tech bust they skipped town and left everyone high and dry. The building is now a standard office park, and most don’t remember who Sun Microsystems even were.
    This is the main reason why I side with Warren Buffett on high tech companies. It’s best to tread carefully. That being said, I have no doubt that we may possibly be in another tech bubble! Great post!

    • I agree with you 100%. It’s almost impossible to distinguish between the next Google/Facebook and the rest that fail. Most tech companies fail. I think Facebook occupies Sun’s former campus now. The back of the Facebook sign on their campus has Sun’s logo, as a way to remind Facebook employees about the importance of hard work and innovation.

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