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Irrational Exuberance: A Tech Crash is Coming

  1. Irrational Exuberance: A Crash in Tech Startups is Coming Jeffrey Funk Independent Consultant and Retired Professor Nobel Laureate Robert Shiller
  2. Irrational Exuberance, by Nobel Laureate Robert Schiller  Schiller’s describes economic bubbles in terms of a  “psychological epidemic”  and thus illuminates “why it is so difficult for smart money to profit by betting against bubbles:  the psychological contagion promotes a mindset that justifies the price increases, so that participation in the bubble might be called almost rational”  He continues: “a new speculative bubble can appear anywhere if a new story about the economy appears and if it has enough narrative strength to spark a new contagion of investor thinking,”  one in which members of the news media “amplify stories that have resonance with investors, often regardless of their validity”
  3. Or In Simpler Terms  Booms and Busts Occur in Cycles of Every 10 to 20 Years  During a boom, price increases lead to more price increases as each increase provides more evidence that increases will continue  The media (and financial sector) provides reasons for price increases thus creating a “narrative” that encourages further price increases  Rising prices for Internet companies in late 1990s led many to believe that rises would continue  New Age Economy of Internet companies justified price increases  These companies would deconstruct and disintermediate value chains  During a bust, the opposite happens with a new narrative driving price declines in which these declines drive further price declines
  4. US Venture Capital Financings Rose Six Times Since 2003: Now higher than previous peak in 2000 2017 Venture Capital Report, Wilmer Hale Silicon Valley’s Unbridled Optimism Gets Fresh Reality Check , WSJ Journal, Jan 22, 2019
  5. But the Number of IPOs Has Not Kept Pace Kenney M and Zysman J, Unicorns, Cheshire cats, and the new dilemmas of entrepreneurial finance, Venture Capital 2018.
  6. Wilmer Cutler Pickering Hale and Dorr, posted on Harvard Law School website, Why? Because Startups are Taking Longer to Go Public (Increase from 2.8 in 1998 to 7.7 in 2016)
  7. And Ones Going Public Have Less Profitability than ones in 1980s and early 1990s (but similar to 1998 and 1999) A Lack of Profitability* is Big Reason Why Startups Aren’t Going Public According to Wall Street Journal: Palantir is among a host of “unicorns”— startups valued over $1 billion—that are losing money years after inception. Uber Technologies Inc. and WeWork Cos. have burned through more than $8 billion and $2 billion, respectively, and still lose money. That’s in contrast to an earlier generation. Facebook Inc. turned an annual profit after five years. Corrie Driebusch and Maureen Farrell, Market Ha Never Been This Forgiving to Money-Losing Firms, Oct. 1, 2018 *and Sarbanes-Oxley
  8. Classic Case of Irrational Exuberance  Price increases lead to more price increases  Media creates a “narrative” that justifies price increases  In current speculative bubble,  increases in both VC funding and valuations of Unicorns are driving expansions in bubble  both types of increases demonstrate new era of productivity improvements to investors, entrepreneurs, policy makers, and media  productivity improvements driven by smart phones, Big Data, Internet of Things, AI, blockchain, driverless vehicles, and robotics
  9. What Happens Next?  But How Will Current Bubble Burst?  What Will be the New Narrative?  And When Will the Bubble Burst?
  10. CountofRounds Number of VC Rounds >=$100M 3-Month Moving Average More Startups Raising Money Privately Through Multiple Rounds with VC funds than Before: Monthly Count of VC Deals, Raising $100M or More Since 2007 Here’s When $100M Venture Rounds Took Over, Jason Rowley, July 225, 2018
  11. The VC unicorn obsession is creating an early-stage funding wasteland, FLAVIO LOBATO, IKOVE CAPITAL@FLAVIOLOBATO NOVEMBER 17, 2018 2:33 PM, VENTUREBEAT Unicorns now have total valuations exceeding $500 billion and VCs probably expect twice that much at IPO time Longer Time to IPO and Multiple Funding Rounds with Private Investors Led to Growing Number and Value of Unicorns (>$Billion Valuations)
  12. The VC unicorn obsession is creating an early-stage funding wasteland FLAVIO LOBATO, IKOVE CAPITAL@FLAVIOLOBATO NOVEMBER 17, 2018 2:33 PM, VENTUREBEAT These Unicorns Receive an Increasing Amount of Total VC Investments in U.S., Reaching 25% in 2018 What happens to Venture Capital if a few big Unicorns fail?
  13. Investment Deals in Early Stage Startups, so-Called “Seeds”, Have Fallen 40% in Last Three Years Silicon Valley’s Unbridled Optimism Gets Fresh Reality Check , WSJ Journal, Jan 22, 2019
  14. Unicorns are Growing Even Faster Globally: New ones in 2018 shown below - 379 in Total In venture capital, it’s still the age of the unicorn, Techcrunch, Howie Xi, Nov 11, 2018
  15. How Many U.S. Unicorns are Unprofitable?  Good data isn’t available because private companies don’t report profits like public companies do  But 82% unprofitable percentage for startups that did IPOs in 2018 suggests high percentage for remaining Unicorns  profitable startups more likely to go public than unprofitable ones so remaining Unicorns are likely to be unprofitable  Plus the many examples of unprofitable Unicorns  ones with huge valuations (Uber, Lyft, Palantir, WeWork)  one that recently did IPOs: see next slide  Slide 12 suggests a few big failures (e.g., Uber, Palantir, Lyft) could upset the VC system Silicon Valley tech bubble is larger than it was in 2000, and the end is coming, CNBC, Keith Wright, 22 May 2018.
  16. Many IPO-Achieving Unicorns are Still Unprofitable  Of 65 who exited the Unicorn list in recent years  One valuation fell below $1Billion  26 were acquired  3 shutdown (Theranos, ModeMedia, Jawbone)  22 (58%) of 37 Unicorns that did IPOs are still unprofitable  Profitable in 2018: Pure Storage, Square, Eventbrite, DocuSign, Sunrun, GoPro, New Relic, Coupa Software, GreenSky, AppNexus, Twilio, Bloom Energy, Groupon, Vonage, Stich Fix  Unprofitable: Cloudera, Nutanix, Razer, Box, Coupons, Hortonworks, Wayfair, Pluralinsight, Blue Apron, Zscaler, Okta, HelloFresh, Forescout, Dropbox, Mongo DB, Domo, Moderna Therapeutics, Snap, Quotient Technology, Pivotal, Roku, Lending Club
  17. Who Will Finance America’s Unprofitable Unicorns?  Venture Capitalists?  How long can they wait for profits?  Probably not much longer because VCs are forcing Unicorns to go public: 2019 is expected to be record year for IPOs  The Stock Market?  Will the Stock Market grant these IPOs with high valuations, ones that provide VCs with sufficient profits?  Falling Stock Market says No (see two slides down), meaning poor return for VCs and thus falling investments  Real Question: How long can hype about technology last? ers_and_Academics_Respond
  18. Record Value of U.S. IPOs expected in 2019  NY Times: With the Economy Uncertain, Tech Unicorns’ Rush Toward I.P.O. Erin Griffith and Mike Issac Dec 6, 2018  Fortune: 2019 on Track to Be Record-Breaking Year for IPOs, Fortune, Oct 19, 2018, Natasha Bach  Get ready for the $200 billion IPO shakeup in 2019, December 17, 2018, Eric Rosenbaum  5 Huge Tech IPOs to Watch in 2019, Guadalupe Gonzalez, December 19, 2018  Barron’s: Get Ready for a Blockbuster Year for Tech IPOs in 2019, John Swartz, Oct 16, 2018
  19. The NASDAQ Was at an All-Time High in August 2018 But Dropped 23% by Early January What happened the last time NASDAQ reached unprecedented levels and investors became impatient with unprofitable firms?
  20. Similarities and Differences Between Bubbles  Growth was emphasized over profits in both bubbles  2000 Bubble  Internet commerce, content, and services provided convenience and lower cost for both consumers and companies  More convenience and lower cost through rapidly falling costs and rising performance of fiber optics, computers, magnetic storage  2019 Bubble  Cloud computing, Big Data, wearable, and mobile apps (e.g., demand economy, m-commerce, fintech) provide convenience  Cloud computing becoming better through improving performance and costs of fiber optics, computers, magnetic storage; mobile apps and wearable by Moore’s Law/smart phones
  21. Big Difference in Magnitude of Benefits  More Internet Applications Created for 2000 than 2019 Bubble  2000: Wide number of applications in commerce, content, services  2019: Cloud computing has many applications, but Big Data limited to marketing. Successful mobile apps limited to niche services such as ride and room sharing, which encounter wide resistance  Bigger Impact of Improvements on 2000 than 2019 Applications  2000: Faster and cheaper fiber optics, computers, and magnetic storage drove search, social media, and video; expanded e-commerce to all industries including fashion  2019 Bubble: Improvements in Moore’s Law (which has slowed as have phone improvements) and Internet speeds barely improve economics of ride/room sharing, wearable, fintech, or m-commerce startups
  22. Large Uncertainties in Other Technologies  AI’s predecessors have had little impact  Rule-based AI was hyped 30 years ago and never succeeded  Big Data and Internet of Things have grown, but little impact on productivity  Improvements in machine learning algorithms are not as visible as Moore’s Law, a big driver of innovation for 50 years  Robotics have also been hyped for 40 years but slow growth in them; now Moore’s Law is slowing  Driverless vehicles will likely take many years  Electric vehicles (and batteries) also uncertain, VC solar bubble burst five years ago
  23. Can Tech Sector Become as Skilled at Government Regulations as They Were With Moore’s Law  Tech sector no longer limits itself to semiconductors, computers, Internet infrastructure, and Internet  Space – Can startups take us to Mars, or even Moon?  Education – Will online learning solve the education problem or are bigger changes needed?  Transportation – How can startups solve the congestion problem without changing public transportation?  Utilities and Energy – How can startups make renewable energy cheaper than current sources?  Finance – How can startups provide cheaper credit? Without Moore’s Law enabling new opportun- ities, can Silicon Valley find and exploit them?
  24. Final Words  A Crash in Tech Startups may be Deeper and Longer than in 2000  Venture capitalists, entrepreneurs, and universities need to ask better questions about what is possible and what is needed