a bubble deflating
Internet payments company Square came to market yesterday. It has a two-letter symbol, SQ, and trades on the NYSE, not NASDAQ. But the most salient fact about the offering is that the IPO price was a lot below the private market value that venture capital investors had placed on SQas little as a year ago.
At the same time, the small number of mutual funds which have been aggressive venture capital buyers in Silicon Valley have been, more or less quietly, writing down the carrying value of their non-public company holdings.
What we’re seeing is, I think, a smaller and much more benign–both for the economy and for us as stock market investors–analogue of the deflation of the Internet mania of the late 1990s that started in early 2000.
the late 1990s and the internet
I remember noticing in 1998, that earlier- and earlier-stage companies were coming to market successfully. Some were little more than concepts. Take Amazon (AMZN), for example, which IPOed in mid-1997. The pre-offering roadshow that I saw emphasized that investors had made gigantic fortunes on buying unknown companies like Microsoft during the personal computer era and that AMZN was a lottery ticket to a similar outcome in the Internet Age. Of course, even a success like AMZN didn’t turn profit for its first eight years as a public company, surviving on the proceed from the IPO and follow-on debt offerings.
I thought at the time, and unfortunately committed my theory to writing, that we were seeing a fundamental change in the role of the stock market in capital formation. Portfolio managers were gradually taking on the role previously played by venture capital. So, I mused, managers of mutual funds like me might have to think about reserving a small place–no more than, say, 5%–of their portfolios for developing companies that they normally wouldn’t have touched with a ten-foot pole.
Not my finest intellectual hour.
today’s bubble deflation
The slow escape of air from the venture capital bubble that is now going on will not have much effect on publicly traded companies, I think, for several reasons:
–the amount of money involved in this speculation is much smaller
–investors of all stripes still wear the scars of 2000-2001, so they haven’t been anywhere near as crazy this time around
–the people who are losing money now are, or represent, wealthy, seasoned speculators, not retail investors
–maybe most important, much of the original internet froth surrounded highly capital-intensive efforts to build a global physical internet transport infrastructure. Names like Global Crossing and Worldcom come to mind.
Yes, too much physical capacity did get built back then, and some builders were highly financially leveraged. But also dense wave division multiplexing, a technological breakthrough in technique (basically, putting glorified prisms on each end of a cable), made it possible for each fiber optic strand to carry 2x, 4x, 8x, 16x ( in 2015 the number is 240x)… more traffic than initially anticipated. Thanks to DWDM, suddenly, despite the rapid growth of internet traffic, an acute shortage of signal transport capacity turned to mind-boggling glut. The transport industry was facing collapse as customers played a ton of potential suppliers against each other for lower prices. Naturally, new construction–and related orders for all sorts of high-and low-tech components, dried up completely. So did investment, employment in civil engineering …and the stocks.
In today’s software world, there’s no equivalent, other than perhaps the market for software engineers. And there are no signs I can see of recession in this arena. Quite the opposite.