The dismantling of the tech sector is more a catharsis than a crisis
After a series of “super clarification” meetings with shareholders, Uber chief executive Dara Khosrowshahi sent an email to employees on Sunday night with a stark message: “we need to show them the money.”
Mutilating his metaphors, Khosrowshahi explained that the market was experiencing a “seismic shift” and the “goals have changed”. The priority for the ridesharing and food delivery business must now be to generate free cash flow. “We serve multi-trillion dollar markets, but market size doesn’t matter if it doesn’t translate into profits,” he wrote.
For the Uber boss, trumpeting cash flow and profits would have seemed about as likely as Elon Musk shouting about the benefits of personal humility and gas-powered cars. No company has been more emblematic of the long, crazy, capital-spiked bull market in tech stocks than Uber. Founded in 2009, the company floated a decade later at a $76 billion valuation without posting a single quarter of a profit. His belated conversion to financial orthodoxy shows how transformed markets have been since the interest rate cycle turned around and the tech-heavy Nasdaq market crashed 26% this year.
As always, when bubbles burst, it is difficult to distinguish between temporary adjustment and permanent change, between cyclical downturn and secular trend. Has the speculative scum just taken off from the top of the market? Or have the rules of the game fundamentally changed for these VC-backed start-ups trying to emulate Uber? My bet is on the latter, but maybe that’s not a bad thing.
There is certainly a strong argument that the extraordinary boom in tech stocks over the past decade was largely fueled by the unprecedented low interest rate policies in response to the 2008 global financial crisis. Capital becoming a commodity , it made sense for opportunists at companies such as Uber to grab as much money as venture capital firms would give them to blitzscale their way to market dominance.
This wild expansion has been accelerated by funding provided by a new class of non-traditional, or tourist, investors, including Masayoshi Son’s SoftBank and “crossover” hedge funds such as Tiger Global. These funds are now experiencing spectacular declines in the valuation of their portfolios. SoftBank just announced a historic investment loss of $27 billion over the past year in its two Vision funds, while Tiger Global lost $17 billion this year.
“There was a unique set of economic and financial policies adopted by the central banks of the world that we had never seen before: sustained negative interest rates over the long term,” explains William Janeway, the seasoned investor. As a result, he says, some companies have pursued “capital as strategy,” seeking to invest their way to success and ignoring traditional metrics. “But I don’t think that’s a reasonable or sustainable investment strategy.”
Stock market investors have drawn the same conclusion and are now distinguishing between tech companies that generate strong cash flow and profits, like Apple, Microsoft and Alphabet, and more speculative investments, like Netflix, Peloton and Zoom. These may have grown extremely fast during the COVID-19 pandemic, but they’re still awash in red ink.
Just as public market investors have moved from cash-hungry growth stocks to cash-generating value companies, private market investors are following suit, says Albert Wenger, managing partner of Union Square Ventures, the capital firm -risk based in New York. “I think it’s healthy. Companies need to create real products and deliver customer value that translates into revenue,” Wenger says, though this shift will prove “very, very painful for a number of people.” companies”.
Life is already getting uncomfortable for late-stage startups looking to exit. Public markets are now difficult to access. According to EY, the value of all global IPOs in the first quarter of 2022 fell 51% year-on-year. The once maniacal market for special-purpose acquisition companies, which allowed highly speculative tech companies to list through the backdoor, has all but come to a standstill. Commercial sales also fell as M&A activity contracted sharply. And late-stage funding round valuations have now fallen in the US, followed by the rest of the world.
Despite this, the venture capital industry remains stuffed with money and desperate to invest. According to KPMG, nearly 1,400 venture capital funds worldwide raised a total of $207 billion last year.
Although cash matters a lot more, the ability of startups to exploit opportunities using cheap and powerful tools such as open source software, cloud computing and machine learning applications remains intact. And a slowdown in big tech companies’ voracious hiring plans could persuade more budding entrepreneurs to give it a shot. “We still need to take a lot more penalty kicks from an investment and societal perspective,” says Wenger. There remains a glaring demand for climate tech startups to invent smarter ways to reduce energy consumption, for example.
Venture capital-backed companies have just surfed the most extraordinary wealth-generating bull market in history. Such supernatural conditions will never happen again. What follows will more likely be catharsis than crisis, as long as they can, like Uber, show the money to investors.
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