We're in the middle of a much-anticipated wave of tech firms listing, and the valuations look a bit frothy. Pandora has 94 million subscribers but doesn't have advertising volume nor premiums to sufficiently monetize them. Groupon has cumulative losses in excess of half a billion dollars, churns 40% of it's paying customers (merchants) and has a high cost of entering new markets. LinkedIn characterized their modest profit as exceptional as they expect to post losses for quite some time, and they're still in search of a sustainable and sizable revenue mix. LinkedIn and Pandora are offering only tiny fractions of their equity (Groupon has yet to disclose the ownership stake they'll offer for the $750m they're seeking), raising governance and investor representation concerns.
These companies are still long-shots. There really isn't anything clever about giving away music at cost and being unable to find sufficient sponsors for doing so. Nor is there in churning 40% of the people who pay the bills. Growth has value but only if it results in a profit, for example, when market share secures long-term revenue stream. It's not yet clear how these firms will capitalize on that growth.
It appears the capital being raised is to be used for share buy-backs that enrich the owners rather than for investment into things that bring these firms into the promised land of profitability. While there's nothing wrong with taking a pay day for one's labours, it does send a signal that those behind the businesses are concerned that the "cusp of success" may be as good as it will ever get for these businesses.
Suppose reality isn't running a faster race than hype, and these businesses never find a way to make their subscriber volumes sustainably profitable, even marginally so. Valuations will turn sour, and tech will lose some lustre.It isn't that hard to imagine. In the past few weeks, Chinese firms listed in North America have, as a group, fallen in value. Many Chinese firms engineered reverse-takeovers: purchasing publicly traded firms listed in North American markets. By doing so, they escaped the scrutiny applied to freshly-listing companies. Several of these firms, notably MediaExpress and Sino-Forest, have been publicly accused of fraud. These accusations have cast a pall over many Chinese firms that have listed in North America. In the same way, an implosion of just a few highly visible firms could very well have the same effect in tech.
Perhaps these newly-listed tech firms contain the seeds of their own destruction. LinkedIn and Pandora have been at it for a decade, yet still haven't cracked the revenue nut. Groupon's founders have a history of growing firms rapidly and taking money out through share buy-backs, only for the firm to hit the skids. In an investing climate characterized by excess liquidity sloshing about in risk-on / risk-off trades, valuations change rapidly.
Suppose a similar pall is cast over tech equities. What would it mean for tech businesses and captive IT?
It might depress capital raising, but if much of that is being done to enrich owners of unproven businesses, that's no loss. Limited tech share offerings to date means limited wealth depletion, a huge benefit given that households are still suffering from excess debt and substantial wealth erosion from 2008 peaks. All told, a tech sector cool down now would be a far less damaging economic event than the dot-com or housing market collapses of recent years.
Capital remains cheap. Assuming the US doesn't default on its public sector debt, markets should have sufficient liquidity without QE3. Tech is still in the throes of a long renaissance with tablets and smartphones (new capabilities) twined with cloud (cheap infrastructure). Cheap, abundant capital and emerging, highly visible technologies suggests that a tech equity collapse wouldn't be particularly harmful to innovation or the willingness to spend on it.It would be especially good news for captive IT, and particularly for tech services firms. Tempered enthusiasm would cool off the tech labor market, which is overheated. This would be good for captive IT in that it reduces sector inflation. It would be particularly good news for tech services firms: as tech demand remains strong, reduced labor costs will improve margins.
The most anticipated listing - Facebook - may never happen. Even without listing, it's still the 900 lb gorilla in the tech sector. For example, LinkedIn is seen by many as a proxy for Facebook because it gives exposure to social networking. Facebook therefore has a significant impact on financial markets, even though there is no sign that the company intends to list. Imagine what would happen in markets if it did: Facebook would be the tide that lifted all tech boats, and the bubble would expand that much further.
Which makes the case that it wouldn't be all together bad for the tech bubble to burst right now. Bubbles are best burst when small.
