Silicon Valley, the new HBO sitcom about six geeks who are, at least in their own minds, already multi-millionaires, douses Silicon Valley’s culture of greed and hubris with hilarious ridicule. The show was put together amidst ballooning hype around startups during the hottest moments of the IPO bubble when everybody was jabbering about “Silicon Valley” as sort of a miracle full of photo-sharing apps. But by the time it began airing, the bottom was falling out from under this craziness – as if the show had pinpointed with impeccable timing the peak after which a long, harsh downturn would set in.
As of the last count, 33 startups in the US alone have a valuation of $1 billion or more, with Dropbox crowning the list at $10 billion. A lot of moolah for a small money-losing company. Not that anyone actually ever paid that much for any of these startups. A “valuation” is a theoretical construct, decided behind closed doors by a few people working for venture capital firms, Wall Street titans, law firms, and the startup. They decide how much money to plow into the company at the next round of funding and what percentage of the company they’ll get in return.
Take SpaceX. Its CEO is hype-magician Elon Musk, whose automaker Tesla produces a couple of thousand cars a month and tons of losses, but thanks to his special gifts, its market capitalization is half the size of GM’s. SpaceX wants to go down the same path. After four rounds of funding, a measly $115 million of actual money has been exchanged for shares, but those who hashed out the terms decided during the last round to magically attach a valuation of $4.8 billion.
A one-sided bet: it’s in no one’s interest to keep the valuation down. The higher, the better for all involved, assuming that everybody will be playing along in future rounds to generate an even higher valuation. Hence this craziness. But there’d have to be that ultimate exit – either through acquisition by a mega-corporation that blindly prints billions of dollars in its own stock in return for next to nothing, or through an IPO to even blinder institutional investors like the mutual funds in your portfolio. Without it, the whole construct would collapse.
Some of these startups are swimming in dough. The top player, Dropbox, raised $507 million in five rounds. The last round earlier this year, hauling in $350 million, established its valuation of $10 billion. The company is in a crowded space dominated by large players, such as Google, with low barriers to entry. So it’s now traipsing around, trying to pick up other startups.
Just today it emerged that it bought photo-sharing startup Loom and document-sharing startup Hackpad. Loom will be shut down, and users have till May 16 to export their stuff before it will disappear into the ether. Hackpad will continue to exist for the time being. Since 2012, Dropbox has bought a number of startups, a useless strategy that tired old tech giants like IBM have turned into their business model. Instead of developing their own space, they overpay to buy into it. It hardly ever works out (see IBM).
And they’re all hoping for that big Twitter exit. But turmoil and losses and whiffs of reeking reality have suddenly replaced blue-sky exuberance.
Twitter is down 39.6% from its peak in December. Facebook is down 18.8%. Biotechs are getting hammered. This comes as a veritable shock in the era of newfangled metrics that make sense only to true believers. It’s a new twist in an era when stock prices have been surgically disconnected from revenues and real earnings; now we’re supposed to swallow “adjusted” future pro-forma earnings that companies and analysts proffer for reasons of convenience.
So a number of recent IPOs are trading below their offering price. Other IPOs have been delayed in the hope for more clement weather down the road. Shares in Weibo, a Chinese microblogging service, started trading on Thursday in the US, where the money appears to be easier and dumber than in China. Why else would they have crossed the pond? The IPO was a success, up 19%. But there was a wrinkle. The shares, offered at the low end of the range at $17 a share, soared to $24.48 before the hot air began hissing out of them, and they settled at $20.47. Time heals all wounds, it seems: after all the disasters involving Chinese IPOs in the US, people swore up and down not to ever again buy these things; now, people are again buying these things.
But perhaps not without second thoughts. And that’s a problem for a “healthy” IPO market, where second thoughts get in the way. And it causes queasiness in Silicon Valley.
“We all feel like we’re at the top of the cycle, and everyone’s skating on new ice,” Nick Beim, partner at venture-capital firm Venrock, told the Wall Street Journal. “Just how thin the ice is not yet clear.”
A healthy IPO market requires a leap of faith, an unquestioning desire to buy no matter what, an eagerness to disregard reality, and total obedience to Wall Street hype. That “healthy” IPO window opens for only a relatively short period of time, and these highflyers get thrown out of it one after the other, and they soar and “create value” and politicians talk about the genius of the American system, and everyone praises the arrival of the “healthy” IPO market. Then they run out of air and crash, one after the other, and sometimes simultaneously, and in the end, it turns out that most IPOs during a “healthy” IPO market are healthy only for Wall Street and some folks in Silicon Valley. For small investors, it’s a complex wealth redistribution scheme that most often does its job out of view deep inside their mutual funds.
Now that VCs have identified the top of the multiyear cycle, they’re trying with all their might to push whatever they can out the window of opportunity while they still can. Their whole business model is based on it. The wealth transfer must go on for as long as possible. And already, investors can be seen scurrying out of the way to avoid getting whacked in the head by crashing IPOs.
“Biotech Stocks’ Rout Perplexes Analysts” the WSJ headlined the phenomenon, as analysts continue to hype this stuff to small investors. But hedge funds are dumping stocks, and private equity firms are dumping their LBOs. That’s the Smart Money. They’re getting out. Read….“It’s not a bubble,” Retail Investors Are Told As The Smart Money Bails Out
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.