Why This Tech Bubble is Worse Than the Tech Bubble of 2000
blogmaverick.com
blogmaverick.com
15 years later, Facebook brings in $3.2 Billion in revenue and has a market cap of ~$41 Billion, or about 12.8 times one year's revenue. [2]
And we won't mention Google, despite the fact that they're the most obvious tech company to compare the likes of AOL to, because they make more money than God, and it would harm the argument. Uber, Twitter, etc. may be overvalued, but they bring in cold hard cash, and they're barely getting started.
Things are frothy right now, for sure; there are some really high rounds being raised that are justified by portfolio theory, and some no-product seed rounds at really high valuations. There will be some major catastrophes, and people will lose a lot of money.
But I have no idea how Cuban could possibly make the argument that it's worse than 1999.
[1] http://en.wikipedia.org/wiki/Mark_Cuban#Business_career [2] http://ycharts.com/companies/FB/market_cap
If things start going south in a private investment, a share holder may not be able to exit even at a large loss.
My original reply was intended to point out that what was the top article comment at the time completely missed the point. Cuban is arguing that severe liquidity restraints are bad, especially so for small time investors. For scenarios like you describe, public exchanges aren't perfect either, but they are very, very good at facilitating near-instantaneous liquidity and they strictly dominate the current set of private crowd funding vehicles.
The thing I'm frankly most worried about is interest rates, which will be the thing to reset the current angel situation. If interest rates rise, it's likely some of the more levered investors will have a safer place to put their cash than LPs. Seems like it'd be an inverted stage crisis where people either can't raise late stage rounds and maybe that stops up the front?
This is all with about 5 minutes of thought.
"In a bubble there is always someone with a “great” idea pitching an investor the dream of a billion dollar payout with a comparison to an existing success story. In the tech bubble it was Broadcast.com..."
And then participates in a television show where 'shark investors' ridicule others for their 'insanely high valuations', which are sometimes as small as 20x one year's revenue.
Yahoo ended up shuttering the business not long after the purchase. They couldn't make it work.
While I won't to pretend to understand the details behind the article, but just looking at the many "startups" without a clear business plan, revenue stream not to mention profits which are valued in billions of dollars all of a sudden should make everyone's eyebrows rise if just a little.
10-15 years ago if you made an exit in 100's of millions it would be a worldwide sensation, these days it seems you sneeze and get 100M in funding and the WSJ posts an article about your company being valued higher than the GDP of some developing nations.
I remember when in the mid 90's Checkpoint got like 70M $ in it's NASDAQ IPO which was then a sensation which was talked about for year, these days that's considered a cold round 2 funding run for the next sexting app. Even with "inflation" and all that other nonsense the fact that since 2006-2007 you could probably count at least 40 US techstartups which got valued for over 1bln should hint a that something stinks.
Heck evernote which their current business model seems to be more focused around selling 70$ socks and 200$ messenger bags instead of you know their own actual techonlogy is valued these days at what 4-5bln, really? A company with 18M in yearly revenues after almost 8 years with no real assets to speak off, with a user base smaller than even marginally popular online games with almost no profit that hasn't even returned it's initial investment runs is valued at 300 times their pre-tax income?
Insurance companies and pension funds make up 50% and upwards of an average VC. The rest of the money also comes from sources which directly affect you such as local government, banks, and other "public" institutions. "Rich individuals" on the other hand do make up only a fraction of the VC source funding with less than 2% on average.
And while it's true that it doesn't represent the portion of the money a pension fund has invested in a specific VC. If you look at the breakout of your pension fund you'll find just how ridiculously high that percentage actually is. And BTW an insurance company or a pension fund that gets hit with even 5-10% loss means that tons of people lose coverage, premiums sky rocket and you end up losing more money that you could invest yourself otherwise.
https://www.calpers.ca.gov/eip-docs/investments/policies/inv...
Besides public funds you also have corporate and private funds which also risk a huge portion of their money in risky capital not only VC.
Total VC investments in 2014: $40 billion 300 largest pension funds control: $12.7 trillion
Total annual VC investment is 0.003% of pension fund value. That doesn't even include insurance companies and other smaller pension funds.
It doesn't mean anything when you say half of VC funds come from pension funds. It's still a miniscule amount when looking at the total value of pension funds.
Public pension: 20%
Corporate pension: 7%
Insurance companies: 7%
Union pension funds: 2%
---
"Insurance and pension" total: 36%
1.5. Elsewhere in this thread, dogma1138 suggests that the Bloomberg mention of CALPERS trimming their VC allocation is "to 1 percent, from 7 percent..." What is left off is the crucial kicker: "...of its private equity portfolio." Meaning that even CALPERS is allocating only 0.5% or so to ALL its venture capital managers.
2. The fraction of an institutional portfolio that goes to any one VC fund is usually well under 1%.
How it actually works (foundation / endowment model):
- Estimate asset class returns, volatilities, and covariances. This is done with historical analysis and some forward-looking hand-wave mumbo-jumbo.
- Chart out the "efficient frontier" of expected return per unit "risk" (volatility of return) across several model portfolios (each of which is a set of % allocations to the various asset classes). This makes a nice hyperbola that looks like a "C" and you pick one of the ones in the top left, meaning, more return and less risk.
- That asset allocation will almost certainly look something like:
Public Equity: most
Bonds: second-most
Hedge Funds: small
Private Equity: small
"Alternatives" in vogue at the time (timber, gold, real estate, rice paddies, comic book royalties, whatever): small
- Then, within the "Private Equity" bucket, you divvy that up and do a similar exercise:
Large Buyout: most
Middle-Market: recently more fashionable
Venture Capital: small
- Then, within each of those buckets, you pick a variety of "managers." Probably at least 3-5 in the VC bucket.
- Then, with each VC "manager" (VC firm) you allocate your commitments such that you can have some continuity of investment across the serial funds of that firm. (Note: if you don't have the size or sophistication to manage managers, you might just buy a "fund of funds" to achieve diversification within the VC sub-allocation of your PE allocation).
If an institution has 10% allocated to PE, they might have 2% allocated to VC, and of that, 0.5% might be allocated to a particular manager (firm), and it might well be put no more than 0.25% into a particular fund.
2.5 Insurers and pensions work differently from the above (endowment/foundation model) in some ways, the same in other ways. Crucially they both have to manage the expected liabilities of near term payouts -- but they don't do that with private equity / venture investments, they do it with bonds. See "immunization." They do, however, try to generate a "total return" on the surplus that is not expected to be used near term. Also I'm leaving out minimum 5% spend, etc., I know.
3. It is totally rational to put a small but meaningful sliver of your large portfolio into venture capital, especially and crucially at a time when entire industries (e.g. taxicab, booksellers, maybe internal combustion cars??) can get decimated by technology disruption within a decade. If nothing else, it's like buying a cheap put against the old-line stocks in your portfolio.
4. Yes, VC has its issues but dogma1138 is not pointing out any of them.
So, I'm sorry, but you're completely out to lunch if you think a VC fund or private equity fund is going to cause an insurer or pension "even 5-10% loss [such that] tons of people lose coverage, premiums sky rocket," etc.
The other problem is that today's so called "tech companies" have very little with tech. And, sadly, many companies including Evernote found out that hype pays more that actual working product. So they sell socks: why not? It gives them more revenue then Evernote subscription.
So there will be no new Oracle, new Cisco, new Sun in this bubble... Just bubble...
3rd in my life.... I hope will make money in next one.
1. Very large investors actually don't do anything different. The best game in town is the efficient frontier (modern portfolio theory; essentially, spread the bets around so some zig while others zag). Once you have more than $10 M or so, it becomes worthwhile to start optimizing at the margins; there are things that can be done with tax efficiency that have tiny but real gains, and there are things like exploiting the short rebate and negotiating for special concessions. But as a passive, financially-oriented investor, you're basically playing the diversification game.
2. That said, very large investors almost all get to be that way not by the diversification game, but by the concentration game. Think about the wealth generation period of any industrial fortune: it comes from highly concentrated equity holdings in a corporation undergoing a massive change in valuation (archetypally, profitable growth, although many an investor has done well by changing the valuation through other means, see ESL and K-Mart).
So. The way a person gets super rich is by doing something very different than what you are (should be) doing. And so while they are in that period, their portfolio looks very different. But once they are super rich, if they go to the world's best advisors, they are likely going to get something that looks like a well-diversified asset allocation according to modern portfolio theory.
For most people above $200K income, biggest expense is usually taxes. So it makes a lot of sense for wealthy people to dominantly invest in instruments which has lowest taxes. They take advantage of 15% tax rule for capital gains and also they take massive advantage of real estate sales which are taxed at zero or rates as low as 20%. In addition they can invest in real estate in countries with lax tx policies or where things are very cheap right now such as Italy, Greece and Iceland. Many wealthy also invest in new business projects happening in their social circle. For example, investing another friend's new beach hotel chain or in infrastructure project contract for some government. In these they have advantage that their friends have lot of inside information on how things will go and what are their key strengths, weaknesses and risks. If regular people are allowed to invest in these, they have lot less leverage and no opportunity for timely cash out when things are going to go south. Finally, regular Joe with $100K have far limited avenues for diversification (essentially just stocks and bonds) and even more limited resources for research and re-allocation of assets. Wealthy can literally exercise 100s of options including currency trading, commodities, foreign equities, futures and so on combined with sophisticated call/put options. While a regular Joe probably meets an accountant twice a year, super rich usually have staff of dozen or more in a dedicated office space to continuously analyze and re-allocate assets in realtime. It is not an accident that Bill Gates total networth has more than doubled despite of his massive giving drive and almost a decade long retirement.
Most venture capital funds return between almost nothing and nothing. Most venture capital companies are horrendous stewards of institutional money. You can look up the available data, it's ugly for everything outside the best of the best.
I fail to see how it's worse to take a 97% loss on the bottom 3/4+ of VC firms, as opposed to taking the same total loss on a spread of crowd equity funding investments.
Like when ordinary people invest into the stock market, and buy a company like Adept Technologies (ADEP) that goes from $21 to $6 in ten months (ADEP has been publicly traded for 20 years).
Or buy into a company like Dendreon (DNDN) which goes from $40 / share and a ~$10 billion market cap, to literally worthless in 36 months.
A person with $1,000 can easily lose all of it in the public markets. There's nothing stopping them from drowning in their own ignorance.
Investors often ride investments down, telling themselves in a delusional fashion that their investment will turn around if they just hold out. This occurred rampantly during the collapse of the Nasdaq in 2000/01.
Or companies like Bear Stearns or Lehman, that vaporized in a matter of weeks (Bear went from like $60 to $2 in two trading days), essentially completely wiping out public shareholders. Worldcom and Enron are other similar examples.
It's also quite easy for investors to play with options in the public market and rapidly lose everything. All it takes is filling out one form.
The only part of the economy that contracts in the Cuban scenario is the market for Yachts and Teslas (exaggerating, but you get the point).
The only way it spreads is if there are other macro factors that we haven't been told about by Cuban (because he doesn't know or understand them).
They will definitely lose their bets but it would be excessively simplistic to assume that if a bunch of VC's bust, their bust will not affect the market (stock market, etc) in any way.
Spare me. What are the numbers on those widows and orphans? Because the thing is, tech investment right now is driven by investors and funds—entities that by definition should be able to handle their losses. Entities that by definition are more educated about the downside risk than the tons of John Q Public idiots that were day trading Internet stocks back in 2000.
Maybe the numbers support what he's saying. If they do, I'd love to see them. shrug
He is making up a victim here.
it's an expression, not a literal statement.
While most of that money is going into less risky things like firms who are expanding rather than contracting thanks to the supply of capital, lax regulatory landscape, etc.
The extra employment and associated consumer spending, along with the optimism obtained from a large number of people feeling like "owners" thanks to crowdfunding programs, helps create a culture of ideas and optimism.
And of course if you're rich enough you want to have some money in some highly leveraged, risky bets, and so VCs and LPs are refining that market substantially, helping money flow into it efficiently. Mattermark is an example of serious analytics to help with deal flow that is growing in number of deals far out of proportion to the total dollar amount.
Similarly, "financification" is happening in areas of real estate that have previously been slower markets driven by insider knowledge and minimal transparency.
Financification is actually the broader trend. Companies like Mattermark realize that and are applying it to what they know (startups) but it's also being done at Farmlogs, Reonomy, and many, many others.
Such businesses are pro-cyclical in that they lose value if deal flow slows, not to mention the inevitable liquidity assumptions that underly all such predictive analytics.
I think that the financial instruments needed to truly make these things work medium term are obscure or even banned, so it will be interesting to see how that plays out.
Now he's seeing one derived from crowd funding? I'm not sure whether to think he's on to something, or whether he dislikes the idea of having vastly more competition for the sort of angel deals he frequently does. These new crowd funding sites are pushing up his cost to get into early rounds on good companies. There's no chance he likes seeing his entry fee substantially pushed upwards (lowering his returns); he has frequently pointed out how much he dislikes Silicon Valley's expensive early valuations and has proclaimed he views that as an isolated bubble.
Like penny stocks?
Accreditation rules can seem unfair, but this scenario is exactly what they're designed to prevent. Crowdfunding is a whole different issue. Most crowdfunding campaigns trade products for money, not equity for money. Kickstarter campaigns tend to go bust frequently, but people don't invest their life savings in a crowdfunded project hoping to strike it rich. People with disposable income investing hundreds or thousand of dollars in an idea isn't a sign of a bubble. It might turn out to have deleterious long term effects, but, we'll see.
Maybe I'm not understanding what Cuban is saying here, but it doesn't seem to make a lot of sense.
As for the more fast and loose, "crowdfundy" sites? I have no personal experience there, so no idea. I don't see the upside in investing through them.
Then goes into a better model for inexperienced/new investors by "crowdfunding"
Maybe he should have used another title :/
Who accredits investors?
Is there legal status for this?
"In the United States, for an individual to be considered an accredited investor, they must have a net worth of at least one million US dollars, not including the value of their primary residence or have income at least $200,000 each year for the last two years (or $300,000 together with their spouse if married) and have the expectation to make the same amount this year.""
http://en.wikipedia.org/wiki/Accredited_investor#United_Stat...
-- earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
-- has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
http://www.investor.gov/news-alerts/investor-bulletins/inves...
Even mentioning his company in the same breath as Uber, Twitter and Facebook shows how out of touch he is IMO. Broadcast.com was hardly a business! Those companies have BILLIONS of dollars of real revenue.
> In a bubble there is always someone with a “great” idea pitching an investor the dream of a billion dollar payout with a comparison to an existing success story. In the tech bubble it was Broadcast.com, AOL, Netscape, etc. Today its, Uber, Twitter, Facebook, etc.
In context, what he's saying makes a lot of sense.
And WhatsApp was all set to be the primary social network for a billion people, not yet another video site.
I respect your point, but I don't think I left anything meaningful from my quote.
I"m comfortable calling that a Bubble.
"It was 9 years ago we went public with what was then the biggest first day jump in stock price in IPO history"
Relatively speaking for though AOL and Netscape at the time where not a bad analogy
I would take a poor, but well-educated and well-informed investor in a transparent marketplace light years before I would blindly accept an arbitrary rule that states you can't invest your money where you want to just because you don't have enough.
It's easy to get in and impossible to get out. If things start falling, investors are locked in for the whole ride down. That structure combined with a heady appetite for putting it in the first place primes the pump for a painful crash.
[edit for question] He implies the SEC is restricting mechanisms for adding liquidity to private/crowd funded investments. Any idea if he has a specific proposal in mind?
[1] http://www.amazon.com/The-Misbehavior-Markets-Financial-Turb...
Shark Tank is a pretty good example of this, even if Cuban's not the worst offender on there.
2014 was the second biggest year in the history of the US stock market. More than 275 companies went public to raise more than $85B. In 2000, 406 companies raised about $96 billion. So sure, last year, there were fewer IPOs and they were on average larger than 2014. But this is not a sign of over-regulation.
Heavy SEC regulations did not crush IPOs for SMBs. That's a knee-jerk blame government reaction that conveniently ignores the real reason why IPO-able companies don't go public much any more. They don't need to.
Uber is a good example. Their Series E is coming in at over a billion. Historically, they would have had to turn to public markets for that money.
But the JOBS Act actually made it possible for private companies to stay private a lot longer, because they are no longer penalized for granting stock to their employees, for example.
Personally, I would overjoyed if it was impossible to sell crappy private companies' shares. That would limit the damage to the rest of the economy, but sadly that's actually not the case. SecondMarket, Exhilway private capital market, Campbell Lutyens, Cogent Partners, Probitas Ps and Triago all serve the secondary market for shares of private companies.
If Cuban can't find a greater fool to snap up his shares, he's doing something wrong. There are plenty of venues to offload that stuff.
Cuban also seems to misunderstand liquidity in public markets. Just because a company is listed on a public exchange doesn't mean its shares are liquid. There are many listed companies that see very little trading in their shares on any given day. And if their valuation tanked, for whatever reason, that limited liquidity would evaporate altogether.
During the 2008 crisis, it was impossible to unload many companies' shares without making the price tumble. You just couldn't move a large block.
But I am very much against any attempts to lessen the reporting requirements for IPOs. What people complaining about the SEC have to understand is that if the public lose trust in the markets, we will have absolutely no markets whatsoever. There will be no market for small caps or for big caps of for IPOs of any sizes. And we came perilously close to that with some of the big accounting scandals.
The most important thing about the markets is that the public trusts them. If that creates accounting requirements that are too onerous for some small time ipos, so be it. Because if there is no trust, there are no markets and there won't be any small time ipos anyways.
>The bubble today comes from private investors who are investing in apps and small tech companies. ... >Why ? Because there is ZERO liquidity for any of those investments. None. Zero. Zip.
Is he wrong?
There wasn't previously a very good market for small and medium size investors to get near investing into early stage tech companies nationally. It has been a locked-away market. I know lots of people with single digit million dollar net-worths, none of them have a clue how to get close to interesting tech start-ups for investing purposes.
How does a person from Nebraska, worth $5 million, invest into interesting tech start-ups in Seattle? Until now, that has been extraordinarily difficult, if not impossible.
So now that there is a market for doing just that, why wouldn't prices rise on those investments? It makes perfect sense that they would, and should. Those valuations have been artificially repressed by government regulation.
What Cuban is claiming is a bubble, is more likely in fact a market being unleashed where it was previously forbidden to exist by regulation.
We're a long ways from the next Dr. Koop billion dollar valuation, with a $50+ million round of financing, coming out of crowd equity funding sites.
Furthermore, the bubble dynamic usually requires liquidity. The bubble dynamic happens when prices are going up so much that participants do not care about an underlying valuation but are certain they will be able to sell in the near future for a higher price due to the market momentum. This whole way of thinking, requires liquidity.
If there is indeed a bubble, I do not see how it can logically be caused by lack of liquidity.
Simply put:
1) valuation = price of last share sold * number of shares
2) value = price at least one buyer is prepared to pay for the entire company
Lack of liquidity in private companies generally comes from the fact that you can't buy or sell shares without agreement from the board. So "price of last share sold" is quite simply directly set by the board, people who have a vested interest in this number being as high as possible.
It is normal for valuation to be larger than value (for public companies), but not by much. You could actually buy (very nearly) all of Microsoft for 360 billion dollars (it's market cap). A bubble can probably be best defined as valuation >> value.
Because these are private investments without liquidity, that has prevented a bubble. You don't have people investing just to ride a rising wave and make profits from day trading. Investors this time have to actually look at the chances of the companies themselves, because they're only going to get a payday if the company is wildly successful, and nothing otherwise. If things start to slowdown, there probably won't be a sudden crash, because there's nothing to crash. These companies have ambiguous valuations, and there's no way to cash out, so there can't be a race to be the first to sell.
Did he just compare himself to Uber and Facebook? Wow...
In a bubble there is always someone with a “great” idea pitching an investor the dream of a billion dollar payout with a comparison to an existing success story. In the tech bubble it was Broadcast.com, AOL, Netscape, etc. Today its, Uber, Twitter, Facebook, etc.
[0] - http://finance.yahoo.com/q/ks?s=UA+Key+Statistics (just recently spent ~$900M on acquisitions)
[1] - http://finance.yahoo.com/q/ks?s=MSFT+Key+Statistics
[2] - http://finance.yahoo.com/q/ks?s=GOOG+Key+Statistics
Though he doesn't help his argument by suggesting that well-networked angels are in the same category as equity crowdfunders pumping money into an idea and a 2 minute pitch video.
A stock that is personal and non-transferable once bought, should probably be valued using discounted future dividends. Or discounted buy-out price.
(reads article)
Yep, it's about liquidity.
I bet the HN comments don't mention liquidity categories.
(reads comments)
Nope, not a single one.
How did I know!!!!??!!11
He's right that sub 25M is dead. You're either the next Uber or you're not getting anything. And if that's the case, then money will be on the sidelines waiting for the next big thing, not the next incremental thing. That will cause a shortage of liquidity for new proposals (the dreamers) and keep those capable of bigger proposals busy. (the titans) You will have a liquidity shortage for the dreamers.
He is right. Incremental investment is no longer possible. All you have is a gigantic bar-to-entry for dreamers and when the titan shortage becomes apparent (no amount of liquidity will reveal more titans to keep the game going), the dreamers will be flushed out. A few titans might go down in the fallout as well.
You either solve everything or nothing today. It's an untenable position that will keep liquidity on the sidelines and stifle innovation. It's also very bubbly as you have more money than there are opportunities (As classified by laws) to chase.
The only way the shareholders can cash out is via a sale to a larger (idiot?) buyer (Facebook/Google/Microsoft/Yahoo).
Even worse, a lot of these companies don't really have a clear path to revenue or profitability (like Tinder).
This isn't necessarily a bad thing, but it has created some pretty extreme weirdness at the low end. A friend sent this "Shaming-people-into-taking-cold-showers As A Service" thing to me a while back: http://coldshowertherapy.com/ (to be clear, he was mocking it.)
It's hard to look at that and not ask yourself, "Is it getting kind of bubbly out there?"
That book made me realize that scientific revolutions and financial revolutions go on at the same time. This is because when a new mathematical framework is discovered, scientists use it to reveal nature (which improves labor), and finance uses it to reveal human nature. (which improves influence) Therefore, TWO bubbles exist in parallel:
- The assumption that future labor will be better organized (through science)
- The assumption that better organization will yield greater influence (through finance)
Those bubbles eventually drift, but they can re-synchronize, and right now, finance has outpaced science. Considerably. Smart money is keeping liquidity on the sidelines and awaiting a resynching event: Either finance tones it down or science invents new math.
Here's a gem from the book:
"After the war, the same crisis of confidence came as after the last one, the same blame game started, the same things happened. As usual, we relabeled our own past. Once again we found ways to blame it on someone, and therefore disown it as an event. It was ‘long ago.’ We’re different today though, aren’t we? Such things could never happen again, or so we tell ourselves. On the other hand, the above forecast of 2040 can’t possibly be right. No public forecast can be. Even were it to have proved accurate, had it been kept secret, once published its existence would change our future. Most of us would ignore it, as we ignore most things. But if it strikes a nerve, some of us might work hard to bring it about. Others of us might work equally hard to stop it from happening. Whoever wins, the resulting future won’t be the same as the forecast had stated it would be. No forecast can predict its own effect. It can’t predict how many of us will either fight it or push it, nor how many of us will try to predict how many of us will fight or push and try to profit from that, nor how many of us will try to predict how many of us will try to profit, and thus profit from that. Pattern recognition leads to pattern exploitation. Thus, a public forecast can come true only if none of us cares about it. In other words, our only useful predictions are our predictably useless ones. Call it Gödel’s Inanity Theorem."
> The human race, to which so many of my readers belong, has been playing at children's games from the beginning ... The players listen very carefully and respectfully to all that the clever men have to say about what is to happen in the next generation. The players then wait until all the clever men are dead, and bury them nicely. They then go and do something else. That is all. For a race of simple tastes, however, it is great fun.
[1]: http://www.cse.dmu.ac.uk/~mward/gkc/books/Napoleon_of_Nottin...