Tech Stocks Bubble: This time it’s different. Oh yeah?

An assemblage of Silicon Valley and Wall Street.

But that alone is not a good reason to sit back and enjoy the ride. While bubbles never recur in exactly the same way, some of the same forces are usually at work. In Silicon Valley, history is not repeating itself, but it is starting to rhyme.

The case for “this time it’s different” is easy to summarise. The share of economic activity conducted on digital platforms has grown enormously in a decade and a half. To take just two comparisons: the online audience numbers about 3bn, compared with little more than 400m in 2000. And spending on online advertising has grown from $8bn to $50bn in the US over the same period.

Sure, tech has risen back to a 19.9 per cent weighting in the S&P 500 index, up from about 15 per cent at the start of the decade. But, compared with about 35 per cent in 2000, that hardly looks a stretch (at least, in relative terms, the entire market may be overdue a correction).

This doesn’t mean there isn’t excess. The rising tide has lifted many boats: more than 80 start-ups have seen their valuations rise above $1bn.

Privately, a partner in one of Silicon Valley’s leading venture capital firms admits that, while some of the $1bn companies in his firm’s portfolios justify the price tag, others clearly do not.

Last time, only a handful of tech stocks survived the bust to become industry leaders. There is every reason to believe the same will be the case with the latest crop of companies, as the network effects and winner-takes-all dynamics found in many corners of tech are felt.

Some of the behaviours of dotcom-era entrepreneurs are also repeating themselves, though in a different guise. In the late 1990s, for instance, many companies were built to flip: the race was on to float lossmaking start-ups at extravagant multiples before the music stopped.

This time around, many are being built to be sold to one of a handful of cash-rich acquirers – whether Google or Facebook in the consumer internet markets, or Oracle or SAP in enterprise software. In fast-growing fields such as artificial intelligence, backers of the more mature start-ups complain about the excess of early-stage venture capital flooding in, from investors hoping to sell out quickly to one of the giants.

This strategy will be profitable for some, but the universe of buyers is small. As before, the penalty of missing the exit window is likely to be high. A similar “same but different” effect is apparent in the way that booming tech investment is being used to fuel rapid user and revenue growth – even if the resulting businesses have weak economic foundations.

With valuations based on multiples of revenue, there’s ample incentive to race for growth, even at the cost of low or even negative gross margins. The many taxi apps and instant delivery services competing for attention, for example, are facing huge pressure to cut prices in the hope of outlasting the competition. If not across the board, then in the most competitive markets, this is resulting in hefty subsidisation of customers.

The 2015 equivalent of buying eyeballs is paying for app downloads: games companies and other start-ups pay to have their apps put in front of potential users, hoping to make money later from the free installs. This has become one of the most profitable parts of the mobile advertising business, buoying companies such as Facebook.

Back in the dotcom boom, many companies used the wave of venture money to buy users. “Paying for eyeballs” by spending money on self-promotion was the not so well kept dirty secret. This cash eventually dried up, hitting companies such as Yahoo, which had soared on the advertising money, hard.

But when the venture capital cycle turns and the advertising binge slows, which companies will take the biggest revenue hit?

At this stage, the collateral damage from a downturn would be considerably more limited than last time, given the smaller amounts invested and the far more substantial businesses that have been created. But the clamour among investors to get in on the latest Silicon Valley boom is rising to a crescendo. If this turns out to be the equivalent of 1996, with years of hard partying among investors still to come, then the after-effects could still be very unpleasant.

* Richard Waters is a columnists for the Financial Times of London. You can contact him on [email protected]

(c) 2015 The Financial Times Limited

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