Thoughts on the Tech Bust
Sam Altman wrote something two months ago that is even more interesting to revisit now that markets have corrected significantly. He posited that perhaps instead of being in a bubble, we were actually in a bust. His words would probably ring even more true now:
Many of the small cap public tech companies have taken a beating this year. Companies like Yelp are trading at less than 4 times trailing revenue.
The tech mega-caps are monopolies and have deservedly high valuations. But even then, I would not be willing to short a single one of Apple, Google, Amazon, or Facebook against the S&P. Apple in particular trades at a single-digit ex-cash forward P/E.
2015 has seen the lowest level of tech IPOs as a percentage of all IPOs in seven years. The S&P Tech P/E is lower than the overall S&P P/E. Neither of these facts seems suggestive of a tech bubble.
In particular, he focuses on what is getting all the press attention – late stage private companies (too big to call startups):
So where is the problem? Late-stage private valuations. But perhaps the answer is that these “investments” aren’t really equity—they’re much more like debt.  I saw terms recently that had a 2x liquidation preference (i.e. the investors got the first 2x their money out of the company when it exited) and a 3x liquidation cap (i.e. after they made 3x their money, they didn’t get any more of the proceeds).
This is hardly an equity instrument at all.  The example here is an extreme case, but not wildly so. Investors are buying debt but dressing it up close enough to equity to maintain their venture capital fund exemption status. In a world of 0 percent interest rates, people become pretty focused on finding new sources for fixed income.
Since he wrote this article, Square’s IPO demonstrated the value of liquidation preferences to late investors, as it went public at a lower validation and they still made money. Good Technology sold at a price that made the stock much less valuable to average employees due to later investors’ liquidation preferences. And in general, tech valuations in public markets have come down substantially since November 2nd. Apple is trading below $100/share as of writing this.
At the end of the day, however, the valuations don’t matter quite as much as the press would have you think. In particular for private companies, cash flow and earnings are what matter at the end of the day – if valuations aren’t sufficient, a healthy business can grow without outside capital. If valuations are full or rich, a healthy company will command a good valuation to spur further growth without impacting margins as much (trading equity for that investment money rather than reinvesting the profits, or taking on debt).