Review & Outlook

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Bubbles and Dead Unicorns: A Technology Investing Update

20 March, 2015 by Ben O'Brien in Commentary

Last summer I wrote a series of posts on the debate about whether or not there is a bubble in technology stocks and start ups. Less than a year later the situation has escalated substantially, and one of the most vocal defenders of tech stocks from last year is now urging caution. My comments last year centered around the debate over the private taxi cab hailing service Uber. (Is Uber worth 17 billion? and Uber is Delivering Ice Cream? and Disrupting the Theory of Disruption). When it was valued at $17 billion in the spring of 2014, valuation expert Aswath Damodaran cried foul. He did his own valuation which came to a $6 billion price tag.

bubble

Then in a much-watched confrontation that played out on Damodaran’s blog, venture capitalist and Uber investor Bill Gurley pointed out the flaws in Damadaran’s thinking. He said, among other things, that Uber was not simply trying to capture a share of the global taxi cab business but was actually expanding the whole market. Rather than taking a piece of the pie, it was expanding the size of the pie and possibly making some other pies too. Damodaran addressed all of Gurley points and modified his model slightly, but essentially stuck to his guns, saying that Uber was overvalued and tech investing generally was getting very frothy.

(Source: Fortune)

Now fast-forward nine months. Uber was valued at $41 billion in December and Bill Gurley recently warned in a speech at the South by Southwest technology conference that “There is no fear in Silicon Valley right now. A complete absence of fear.” Asked whether there will be a crash, Gurley said, “I do think you’ll see some dead unicorns this year.” Unicorn is a term for start ups with a valuation greater than $1 billion. A cover story in Fortune magazine last months featured some interesting comments from Gurley and others.

A recent column in MarketWatch listed some tech stocks that are already struggling:

Fancy New Websites: Angie’s List is down 50% in the last year and down almost 80% from its 2013 peak, while Coupons.com is down 65% from its first day of public trading about a year ago. Both continue to suffer from a persistent lack of profits — something that should surprise no one.

Fancy New Data Stocks: In addition to the ugly performance of Box, flash-memory company Violin Memory  is down nearly 25% year-to-date and off 50% from its 2013 IPO.

Fancy New Cloud Stocks: Cloud-based marketing and business software has been fashionable for some time now, but some of the biggest names in the space are sucking wind. Marketo is down 20% year-to-date after an ugly February earnings guidance update that projected worse-than-expected losses, and is off about 40% from its early 2014 high. Netsuite  is “only” down 13% this year, but after it dropped about 30% in short order in the beginning of 2014, investors might want to prepare for more pain to come.

Of course, you might argue that these companies are cherry-picked examples, and that other tech companies are thriving. But this has always been the way that bubbles appear. They are difficult to spot and nearly impossible to time. And amid the impostors there will be a few genuinely good companies like Amazon and Google in the last tech bubble.

The good thing about this possible bubble is that as a result of the fact that so much of the hype and the investment has taken place in private companies by venture capitalists, a crash might not have the same systemic effects that the dot-com crash had in 2000 when many individual investors went whole-hog into tech stocks. Still, it is worth keeping an eye on potential trouble in the tech sector. Bubbles can be painful. Fifteen years after the dot-com crash, the tech stock-heavy Nasdaq index is still just below the high it reached in 2000.