Showing posts with label tech sector. Show all posts
Showing posts with label tech sector. Show all posts

Thursday, November 15, 2018

15/11/18: The 'New Normal' is a Road to another Tech Sector Bust


The VC land of wonders and waste is awash with cash, thanks to a decade-long loose liquidity pumping across the markets by the Central Banks. Just as in the prior iterations of the same (the Dot.Com Bubble and the pre-GFC assets binge), the outrun will be the same as it was before: a crash.

TechCrunch reports that (https://techcrunch.com/2018/11/11/age-of-the-unicorn/):

  • Over the last 5 years, the number of 'unicorns' - startups with valuations in excess of USD1 billion - has grown from 39 to 376 - almost a ten-fold increase
  • The rate of 'unicorns' emergence is accelerating: in 11 months through November 1, 2018, we've added 81 new 'unicorns' to the roster, which means there is now a new 'unicorn' company launched every four days
  • Mega-deals for start ups - funding rounds in excess of USD100 million - are also on the rise, with their frequency up ten-fold on five years ago. "Back in 2013, there were only about four mega rounds a month, but now there are forty mega rounds a month based..." Thus, "starting from 2015, public market IPO has for the first time no longer been the major funding source for unicorn size companies."

As the chart above shows, there has been a power-law acceleration in the trend since mid-2017 and it is now clearly topping the asymptote.

Two countries dominate the 'unicorns' league: China (with 149 count) and the U.S. (with 146 count). Which implies two things: 
  • Given the close links between the PBOC policies, Chinese Government investment strategies and supports, and China's counts of 'unicorns', majority of these start ups are heavily dependent on debt, and political good will. They are sitting ducks for ESG risks and are extremely exposed to political and policy uncertainty.
  • The U.S. 'unicorns' are completely dependent on the markets ability to cycle cash from corporate and financial sectors debt and private equity into start ups funding, and M&As. There is zero rational valuation happening in this sub-sector.
A dramatic shift in risks from tangible tangible technologies (including strongly patentable innovation or defensible market shares) of the likes of Apple and Google toward less tangible, highly price and income elastic SaaS types of product offers is reflecting the massive buildup in valuations risks. This too is reflected in the article, albeit the authors fail to spot the implications. TechCrunch conclusion is perhaps even more alarming that the stats they present. "Mega rounds are the new normal; staying private longer is the new normal; and the global composition of the unicorn club is the new normal." We've heard exactly the same arguments at the tail end of the Dot.Com boom about the absurdly over-valued early internet age companies. We've heard exactly the same arguments about the real estate sector prior to 2008. We've heard exactly the same arguments about tulip bulbs in Amsterdam some centuries ago too. 

'The new normal' is the old road to a bust.

Thursday, August 10, 2017

10/8/17: 2Q Start Ups Funding Data: Big Lessons Coming


2Q 2017 figures for seed funding and startups capital rounds is in, and the slow bleeding of the Silicon Dreams appears to be entering a new, accelerated stage. 

Seed funding posted continuous declines over the last two years, falling some 40 percent on 3Q 2015 peak in terms of number of transactions and down 24 percent in volume. 


Source: PitchBook Inc

Combined seed and angel investment deals numbered just 900 on 2Q 2017, down 200 on same period in 2016 and well below ca 1,500 deals completed in 2Q 2015. In volume terms, 2Q 2017 came in with total investment of $1.65 billion, down on $1.75 billion in 2Q 2016 and $2.19 billion in 2Q 2015. Masking these falls somewhat, terms of investments have tightened significantly over the last two years, meaning that actual in-hand capital allocations have fallen more than the headline volume figures suggest.

There are some reasons for this decline. Firstly, recent tech IPOs signal Wall Street’s growing scepticism over unicorns valuations of tech companies. Secondly, the quality of new deals coming into the market is slipping: if two years ago everyone was chasing mushrooming sector of ‘Uber-for-X’ companies, today the ‘disruption’ pitch is getting old and the focus might be shifting on later stage financing of already existent companies.Thirdly, investment funds are facing internal problems - the classical allocation dilemmas. As funds under management rise in the angel and VC investment outfits, it becomes harder and harder for them to meaningfully allocate small investments to smaller start ups. They become more dependent on ‘finding the next Uber’. As a result, the funds are shifting their cash to already existent early stage companies, away from angel and seed finance. 

To see the latter two points, consider the median seed deal size. Two years ago, that stood at around $500,000. Today, it is at around $1.5 million. 

There is also the issue of timing. Boom in seed funding in tech sector is now good decade long. And it is time to count the proverbial chickens. As the industry pursued the investment model of ’spray the cash around and pray for a return somewhere’, a range of seed finance funds are closing down and posting poor returns. This, in turn, makes new investors more cautious.

Why this is significant? Because many tech start ups generate no meaningful revenues and, even at later stages of development, once revenues ramp up, they tend to run huge losses. The reason behind this is that many tech start ups (especially the larger ones) pursue business models based on aggressive expansion of market share in markets (e.g. taxis and food deliveries) where traditional business margins are already thin. In other words, by pursuing volume, not profit, the start ups must use increasing injections of capital and large capital allocations up front to stay afloat. 

This, of course, is not a sustainable model for business development. But tell that to the politicians and business leaders and investors, all of whom tend to chase size before understanding that business needs to make profits before it can raise employment and build brand dominance.


So for the future, folks: stop chasing pre-revenue, business plan (or tech platform)-based funding. Focus on generating your first sales and showing these to have margin potential. Remember, corporate finance matters not so much on the capital budgeting side, but on the cash flow spreadsheet. 

Wednesday, June 28, 2017

28/6/17: Tech Financing and NASDAQ: Divorce Proceedings Afoot?

Based on the recent data from Kleiner Perkins,  there has been a substantial inflection point in the relationship between NASDAQ index valuations and tech IPOs around 2015 that continued into 2016-2017 period.

Over the period 2009-2014, the positive correlation between NASDAQ and global technology IPOs and PE/VC funding was largely a matter of regularity. Starting with 2015, this relationship turned negative. Which means one pesky thing when it comes to the real economy: the great engine of enterprise innovation (smaller, earlier stage companies gaining sunlight) as opposed to behemoths patenting (larger legacy corporations blocking off the sunlight with marginal R&D) is not exactly in a rude health.

Monday, November 11, 2013

11/11/2013: A Great Tech Future for Ireland… or a Bubble? Sunday Times, November 10


This is an unedited version of my Sunday Times column from November 10, 2013.


Depending on which measure one uses Ireland slipped into the Great Recession as far back as in the mid-2007. Since then and through the first half of this year, our nominal Gross Domestic Product is down 15.3 percent or EUR14.55 billion. Despite the claims about the return of growth, played repeatedly from early 2010, our economy posted 19 quarters of negative growth and only 7 quarters of expansion.

These numbers reveal the unprecedented collapse of the domestic economy, ameliorated solely by continued growth in exports, primarily driven by the multinationals. At the end of last year, total exports of goods and services from Ireland were up 16 percent on 2007 levels. However, the latest global and domestic trends suggest that this growth is at risk from a number of factors. These include both the well-known headwinds that are currently already at play, as well as the newly emerging signs of distress. 

The former cover the adverse impact of the ongoing patent cliff in pharmaceutical sector and the continued migration of manufacturing to Eastern and Central Europe and Asia-Pacific. Added pressures are building up from our competitors for FDI, such as the Netherlands, Belgium, Sweden, Finland and, more recently, Austria.

The risks that are yet to fully materialise, however, pose a threat to the biggest post-2007 success story Ireland has had - the Information and Communications Technology (ICT) services. This sector, most often exemplified by the tech giants, such as Google and blue chip firms such as Microsoft. More trendy and smaller players include the games developers, cloud computing and data analytics enterprises, as well as on-line marketing and advertising companies.

While easy to discount as being only potential, these threats are worrying. 

Since 2007, goods exports from Ireland grew by a cumulative 2.1 percent, against 33 percent growth in exports of services. If in 1998-2004 goods exports averaged over 67 percent of our GDP, today this share has declined to 51 percent. Meanwhile, share of services exports rose from an average of 23.3 percent of GDP in 1998-2004 period to 58.4 percent projected for this year. More than half of this growth came from ICT services.

More importantly, as the Budgets 2012-2014 have clearly shown, the Government has no coherent plan for supporting the growth capacity of the domestic economy. This means that the entire economic strategy forward remains focused on the ICT services to deliver growth in 2014-2015. 


And herein lies a major problem. Increasingly, international markets and global developments are signaling the emergence of an asset bubble within the ICT services sector. These signs can be grouped into three broad categories.

Firstly, we are witnessing the development of a bubble in investors' valuations of the ICT companies. Controlling blue chips, tech valuations have grown over the last decade at a pace roughly double that found in other sectors. Many tech stocks are currently trading in the range of 25-50 times their sales, dangerously close to the levels last seen at the height of the dot.com bubble. Last 18 to 24 months have also seen a series of tech IPOs with post-listing annual returns in 50 percent-plus ranges - another sign that investors are rushing head-in into the sector. Meanwhile, blue chip technology companies are trading near or below their multi-annual averages, suggesting that hype, not real performance is the driver of the market for younger firms. MSCI ACW/Information Technology benchmark tech stocks index is up ca 90 percent over the last 5 years. Recent research from PWC shows that IT sector M&A deals in Q3 2013 were up 34 percent year on year.

Secondly, costs inflation is now driving profitability down across the sector. Take for example Ireland. In 4 years through June 2013, average weekly earnings in the economy fell 1 percent. In the ICT sector these rose 11 percent. Back in Q2 2009, ICT sector posted the third highest average weekly earnings of all sectors in the Irish economy. This year, it was the highest. Other costs are inflating as well. Specialist property funds with a focus on the tech sector, such as Digital Realty Trust, are awash with cash from their massive rent rolls.

CSO publishes a labour market indicator, known as PLS4. This combines all unemployed persons plus others who want a job but are not seeking one for reasons other than being in education or training and those who are underemployed. In Q2 2013 this indicator stood at nearly one quarter of our total potential workforce. Yet, the ICT services sector has some 4,500-5,500 unfilled vacancies. With tight labour supply, stripping out transfer pricing in the sector, value-added is stagnating in the sector, implying lagging productivity growth.

Thirdly, as in any financial bubble, we are nearing the stage where the smart money is about to head for the doors. In recent months, seasoned investors, ranging from Art Cashin, to Tim Draper to Andressen Horowitz announced that they cutting back their funds allocations to the sector. 

To see how close we are getting to forming a bubble, look no further than the recent fund raising by Supercell - a games company - which raised USD1.5 billion in funding in October. The firm has gone from zero value to USD3 billion in just three years on last year profit of just USD40 million. The investor who financed the Sueprcell deal, Japan's Masayoshi Son is now declaring that he is investing based on a 300-year vision for the future. Expectations and egos are rapidly spinning out of synch with reality. In tandem with this, Irish politicians are vying for any photo-ops with the ICT leaders and industry awards, summits and self-promotional gala events are musrooming. In short, the sector is becoming a new property boom for Ireland's elites.

Global ICT services sector hype is pushing up companies valuations across the sector and delivering more and more FDI into Ireland. This is the good news. The same hype, however, also brings with it an ever-increasing international exposure of Ireland's tax regime, the main driving reason for the MNCs locating into this country. This, alongside with rampant wages inflation and skills shortages, is one of the top domestic reasons for the tech-sector vulnerability. 


Overall, risks to the ICT services sector are material for Ireland. Our economy's reliance on the tech sector FDI has grown over time, and even a small contraction in the sector exports booked via Ireland can lead to us sliding dangerously close to once again posting negative current account balance. 

Our capacity to offset any possible downturn in the sector with other sources of growth has been diminished. Post-2001 dot.com bust we compensated for the collapse in ICT and dot.com companies activities by inflating property and Government spending bubbles. This time around all three safety valves are no longer feasible. Between Q1 2001 and Q2 2003, ECB benchmark repo rate declined from 4.75 percent to 2.0 percent. Today, the ECB rates are at 0.5 percent and cannot drop by much into the foreseeable future. 

Besides credit supply, there is a pesky problem of credit demand. The evidence of this was revealed to us last week, when we learned that the Government Seed and Venture Capital Scheme (SVCS) and the Micro-enterprise Loan Fund turned out to be a flop. Both schemes are having trouble finding suitable enterprises to invest in. May we wish better luck to yet another ‘state investment vehicle’ launched this week, the ‘equity gap’ fund for medium-sized companies.

Ireland's policymakers today have little to offer in terms of hope that we can weather the next storm as well as we did ten years ago. 

Based on numerous multi-annual initiatives by the Government and business lobbies, Ireland’s 'new school' of economic thinking post-crisis is solidly focused on tax incentives to rekindle a new property and construction boom and on advocating more Government involvement in the economy. The latter includes such initiatives as more state investment and lending schemes for SMEs, a state bank, state-run agencies to sell services to foreign state agencies, state-supported access to exports markets, and state-funded R&D and innovation. 

This reality is compounded by the fact that in recent years, much of our development agencies attention has focused on attracting smaller and less-established firms and entrepreneurs from abroad to locate into Ireland. Both IDA and Enterprise Ireland have active campaigns courting these types of ventures. Of course, such efforts are both good and necessary, as Ireland needs to continue diversifying the core base of MNCs trading from here. Alas, it is a strategy that not only brings new rewards, but also entails new and higher risks. Should the tech sector suffer significant market correction, in-line with dot.com bubble bursting or banking sector crisis, majority of the younger firms that came to Ireland to set up their first overseas operations here will be downsizing fast. Unlike traditional blue-chip firms, these companies have no tangible fixed assets. They own no buildings, employ few Irish workers and have no technology domiciled here. For them, leaving  these shores is only a matter of booking their flights.

In short, our policy and business elites seem to be flat out of fresh ideas and are ignorant of the potential threat that our over-concentration in ICT sector investment is posing to the economy. Let’s hope the new bubble has years to inflate still, and the new bear won’t be charging any time soon. 




Update: new article on the topic from the BusinessInsider: http://www.businessinsider.com/4-billion-is-the-new-1-billion-in-startups-2013-11



Box-out:

Just when you thought the Euro crisis is nearing its conclusion, here comes a new candidate state to join the fabled periphery.  Last week, the IMF concluded its Article IV consultation assessment of Slovenia. The Fund was more than straightforward on risks and problems faced by the country bordering other ‘peripheral’ state – Italy. Per IMF: “Slovenia is facing a deep recession resulting from a vicious circle of strained corporate and bank balance sheets, weak domestic demand, and needed fiscal consolidation. Cleaning up and recapitalizing banks is an immediate priority to break this cycle.“ Some 17.5 percent of all assets held by the Slovenian banks were non-performing back in June 2013. Worse, over one third of all non-performing loans were issued to 40 largest companies in the country, putting strain on the entire economy. Corporate debt is so high in Slovenia, interest payments account for 90 percent of all corporate earnings. If that is a ‘cycle’ one might wonder what constitutes a full-blow crisis? Spooked by the Cypriot crisis ‘resolution’, Slovenian Government has so far rejected the use of international assistance (re: Troika funding) in addressing the crisis. However, the country fiscal deficit is running at 4.25 percent of GDP, net of banks’ restructuring and recapitalisation costs. In other words, Slovenia today is Ireland back in 2010. Brace yourselves for another Euro domino falling.