Hacker News Reader

Comment by tempsy | Hacker News Reader

you’re confusing cause and effect.

tech valuations have come down because the Fed has raised rates which long duration stocks like growths tech cos are extremely sensitive to.

when borrowing money becomes more expensive, these companies can no longer fuel business expansion or stock buybacks with cheap debt, and at the same time facing a demand issue because consumers are facing the same phenomenon.

lower growth projections combined with expanding operating costs due to headcount are unsustainable for growthy tech firms that normally burn a lot of cash to fuel growth, so it becomes necessary for these firms to slow hiring and layoff workers to slow their burn and conserve cash.

View on HN

I did mention interest rates, indirectly: "Now that investors are more discerning with their money [because the risk-free rate of return is now non-zero]..."

Interest rates play a role, but it's not the direct cause you're thinking of. The value of a company is related to the risk-free rate of return, i.e. interest rate set by the government. Lower interest rates produce higher valuations, and higher rates produce lower valuations. But just because a company's market value goes down as the interest rises doesn't mean the company was inherently overvalued at the lower interest rate.

What we saw in the tech market was that companies were overvalued. The change in interest rate was the catalyst for tech's value adjustment, but the companies were overvalued at the old interest rate, too, because their value was based in-part on unrealistic growth expectation. Also, ZIRP really messed with market dynamics. Look at crypto, which is something that has near-zero utility and thus should have near-zero value, especially all the random shitcoins. Many such shitcoins were worth many millions / billions of dollars. The market was clearly irrationally valuing many different types of assets.

How do you know the tech companies were overvalued at the old interest rates, and it wasn't just a due to interest rate changes?

It seems pretty obvious if interest rates are high, tech companies which make most of their profits far in the future were going to be worth less than value companies where most of their profits are in the short term.

> tech companies which make most of their profits in the future

Nobody can predict the future, not even you.

You don’t need to predict the future. The fair value of a company is the discounted future cash flows. Increase the discount rate and the valuation falls

Nobody knows future cash flows.

I think if you're an investor and you value companies not just on how they are doing today but but how you think they will do in the future you will be more successful than if you just look at today's numbers.

> How do you know the tech companies were overvalued at the old interest rates, and it wasn't just a due to interest rate changes?

Obviously I can't know one way or the other, but I laid out my personal belief in the original post. Essentially, many "tech" companies are just digital versions or existing business and products. In such cases, there isn't as much value to capture compared to unlocking massive amounts of human potential like a company like Google. The market, however, was valuing these two types of tech companies the same. Peloton is a good example. Peloton is a great product and can really make a dent in the home-gym market. But the home-gym market is already relatively mature, so Peloton really shouldn't have been commanding such insane multiples on any metric (sales, revenue, cash flow, etc.)

I think the 100's of intelligent sophisticated investors that influence the price of the market didn't suddenly start to understand the fundamentals of companies they didn't before because of a change in interest rates.

It makes much more sense they just plugged in a higher discount rate to their models.

Peloton has fallen because they went from a company with rapidly growing revenue to one falling revenue.

> Peloton has fallen because they went from a company with rapidly growing revenue to one falling revenue.

Exactly. Their growth expectations were unrealistic. They were bringing a marginally better product to a saturated market under the guise of being a tech company. They could be a good business if run lean, but they’ll never realistically command insane multiples on revenue.

i'm confused by this automatic lumping together of "tech" and "growth". Will Google or Facebook make most of their profits far in the future? Is the universal expectation for Google to double next year? and people ran out of patience and dumped Google stock so that it halved in value? of course not, something else drove this.

Ah, I see we're buying into Elon's logic, here.

Big companies like Facebook aren't funding their operations with debt. They're absolutely flush with cash. Your claim that the fed raising rates is causing layoffs in these large, profitable companies does not hold water.

Does that help to explain a retreat in VC- and other debt-funded entities? Sure. But the headline layoffs we've seen are not in those types of companies.

Now, I do agree that growth projections were revised down, but the explanation for that is much simpler: A lot of companies assumed COVID was going to create a lasting impact on the world that would result in endless growth and revenues for companies like Peloton, Zoom, etc.

Well, that didn't happen, and they are now forced to cut back on staff after over-hiring due to those bad projections.

This pattern is visible across the industry. It's not in the least bit mysterious.

I'm not the GP, but the rebuttal to your point about interest rates is that it is not about using cash vs debt. GP was making the point that interest rates affect NPV calculations ie future cash flows of the company have to be discounted at a higher rate

That's not actually a rebuttal to my point.

Discounting NPV of future cashflows affects stock price, and increased interest rates mean a greater discount. No argument there.

Okay.

So what?

Why would a dropping stock price motivate layoffs?

The GP's claim is that it's because it makes debt more expensive (which it does!)

> when borrowing money becomes more expensive, these companies can no longer fuel business expansion or stock buybacks with cheap debt

But unless you're funding your operations with debt, that just doesn't matter that much, and in fact it can have a positive effect because it makes stock buybacks cheaper (looking at you, Apple).

Now, you could make the argument that maybe shareholders see a dropping stock price and push for layoffs to protect their investment.

Okay.

Except a lot of these companies have dual-class shares. Meta can (and does) simply ignore their shareholders. If they're laying people off, it's because Zuck decided they should.

The best explanation I see is bad long-term projections of the fallout of COVID, combined with social contagion as tech would rather sell the idea that there's a major recession imminent and they're cutting proactively, rather than admit they just screwed up and over-hired.

Wouldn't NPV of future cash flows dropping mean you may have less cash flow in the future to pay for employees you may have hired anticipating those cash flows?

So the way interest rates factor into cashflow analysis is in the opportunity cost to the investor of investing in a particular asset. That is, if interest rates rise, that means I can probably find greater yields elsewhere, which for a stock means I should increase my discount rate.

https://seekingalpha.com/article/137623-how-interest-rates-i...

> First, assume that our opinion of future free cash flow doesn’t change so as to isolate the effect that the discount rate will have on value. You can think of the discount rate as the opportunity cost of investing in Stock A over Stock B or Investment C. If interest rates rise, so too should our discount rate since we would have more opportunities to do more with our money elsewhere. And since discount rates and present values are inversely related, value will decline, all else equal, as the result of a rise in interest rates.

https://www.graduatetutor.com/corporate-finance-tutoring/cas...

> The first way in which interest rates factor into a DCF model is through the discount rate. The discount rate captures the rate at which the value of money declines. Prevailing interest rates are a big factor in opportunity cost. And opportunity cost is an ingredient of the discount rate.

https://www.investopedia.com/terms/d/dcf.asp

> Calculating the DCF involves three basic steps. One, forecast the expected cash flows from the investment. Two, select a discount rate, typically based on the cost of financing the investment or the opportunity cost presented by alternative investments. Three, discount the forecasted cash flows back to the present day, using a financial calculator, a spreadsheet, or a manual calculation.

So DCF analysis doesn't actually say anything about company's actual future cashflows. It's about the value of those cashflows to the investor when weighing the value of that stock versus other types of investments.

Bringing us back to the topic at hand, that means higher interest rates should depress stock prices because of the increased opportunity cost versus investing in other assets.

Excellent summary. It's always about opportunity cost and relative prices, because people always have options. Employees can go where they are paid more, investors can invest where the returns are higher, consumers can choose the better value. The world is filled with businesses that had positive operating margins but nevertheless declared bankruptcy because their funding costs were too high.

By the way, you're certainly right that increased interest rates depress the NPV of capital expenditures as the cost of capital increases.

That means businesses planning to, say, open a new factory or expand into a new market, might choose to delay or cancel those plans, and that can certainly impact growth projections.

But the tech megacorps aren't typically growing that way anymore. And even in the case of a company like Meta, which is investing heavily in their "metaverse" vision, they're funding that with cash because they're money printing machines.

> just screwed up and over-hired

what's weird to me is that this is happening at all kinds of companies, including ones with what I thought was pretty level-headed management. It's not just one company oops screwed up and over-hired, and "tech" is not really a monolith. Yet, they somehow all simultaneously screwed up and over-hired?

This is the social contagion part of the theory.

The idea is that many--especially very high profile companies--overhired, and the rest are following the leader.

Stir in media hysteria around purported recessions and you can understand why leadership might start to pull the reins.

The meme-y-ist of tech stocks like Peloton weren't doing stock buybacks.

The idea that Apple is "taking on debt to buy back stock" is pretty misleading. Sure, Apple has some debt - but it has net cash. Ditto for the rest of the megacap tech stocks.

i didn’t say every company was. this is mostly true of the mega cap companies.

and it’s not misleading at all. Apple and Meta are both known to sell bonds aka taking on debt for the primary purpose of buying back their own stock. that doesn’t have anything to do with their multibillion pile of cash.

Meta has sold a single bond, in August of 2022. That isn't a pattern and it isn't enough for them to be "known to sell bonds to buy back stock"

They got caught in the hype and lost a lot of money.

Apple has many times. I don’t know why this is suddenly a conspiracy that some mega cap tech firms used cheap debt to buy back their stock. It’s not. It’s actually the primary way that these companies hid dilution from investors due to employee stock comp.

GP is missing one of the major reasons for tech stocks to fall in a rising rate environment. (They're probably not missing knowing it, but missed saying it explicitly.)

When risk-free rates of return increase, that harms the value of all growth companies by increasing the discount rate applied to future cash flows (while not giving a corresponding "credit" for near-term losses of cash)

Higher interest rate was the catalyst to recognizing reality, not so much a fundamental shift of financials.

Many of these companies were losing money and their future imaginary positive cash flows were wishful thinking given their business models. Higher interest rates accelerated loss in value as the speculative sentiment shifted to a more risk-averse posture once the market accepted the reality that was always there: these companies never exhibited the ability to make any money, plus they were cannibalizing themselves due to the extreme competition from other startups fueled by the huge amounts of money vc’s were able to gather during the zero interest rate mania.

Discounting future negative cashflows was always a foolish game.

I think changing interest rates can easily (and often do) cause a fundamental shift of financials.

If I have a company that will lose 100 units of currency this year and next year, break even the year after that, and then return 20 units of currency for each of the next 17 years, then vanish without a trace, that's worth positive 46 units of currency at a 3% discount, nothing at a 5% discount, and negative 37 units of currency at a 7% discount rate. (Whether you discount the initial losses changes the analysis by only a small amount.)

Discounting of cash flows is not what I consider to be “financials”. Financials are the output / cash flows themselves not the speculative investment calculation of future flows given a determined discount rate.

Initial cash flows weigh much more heavily than later cash flows, so initial losses in a cash flow series have a much larger impact on npv. Therefore, I disagree with the conclusion of your hypothetical.

> these companies never exhibited the ability to make any money

the most talked-about layoffs right now are happening at salesforce, facebook, amazon, etc. I'm not sure what you are trying to convey or which hypothetical companies you are talking about, but these are printing money.

My analysis is not limited to the “most talked-about layoffs” (whatever that means) nor is it limited to some cherry-picked old cash-cow behemoths that are going to have much slower growth rates going forward. Possible exception is Facebook if they can make the VR bet work, but I have serious doubts about VR being commercially profitable within the next 20 years and even more doubts Facebook will be the company to make this happen.

The reason they take out debt to buy back stock is generally that they don't want to pay tax until later.

Are you talking about why Apple has so much cash in Ireland?

Why can't Apple buy its stock from Ireland without paying more taxes?

> tech valuations have come down because the Fed has raised rates which long duration stocks like growths tech cos are extremely sensitive to.

That's actually not accurate. NTM revenue multiples for software companies peaked at ~12.0x on average in October 2021. The first rate hike in this cycle happened in March 2022.

While true, the market is based on forward-looking expectations. Values drop before the first rate hike if people begins expecting a rate hike.

You're describing part of a tax-management strategy: sell bonds in the US, secured by cash in an offshore tax haven (e.g., Ireland), use the proceeds to return cash to shareholders, pay the bond coupons out of cash flow, and write off the interest payments. It has everything to do with the pile of cash when it's cheaper to use debt secured by the cash than to pay taxes to repatriate the cash. If worse comes to worst, the cash is still there to make bond-holders whole.

The thing about explaining market movements is: you can't. And if you could, you would me making money over fist, not sharing that on some forum.

edit: no, you can't... post hoc correlation analysis is an exercise in obscurity. If there was internal logic to the movements looking back, there would be a possibility of forecasting them.

You can't predict, and coming up with an explanation during the fact is very problematic. But it's certainly possible to explain things after the fact.

You can in hindsight. What you said is meant to be about predicting market movements.

That doesn't sound right. Nobody could predict that Covid (and reaction to it) would hit worldwide in March 2020. But looking back, you can try to unpack what effect it had on the markets. That's not going to help you predict the next one.

Sounding right, gut feeling, these are staples of bad reasoning. Markets have long term gains and random walks when you zoom in. That's it. Over the past years millions of things happened and hundreds of markets behaved as markets do. Cherry picking is easy, and wrong.

Reply on news.ycombinator.com