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Technology firms: Frothy.com
- Dec 20th 2014
IN DECEMBER 15 years ago the dotcom crash was a few weeks away. Veterans of that fiasco may notice some familiar warning signs this festive season. Bankers and lawyers are being priced out of office space in downtown San Francisco; all of the space in eight tower blocks being built has been taken by technology firms. In 2013 around a fifth of graduates from America’s leading MBA schools joined tech firms, almost double the share that struck Faustian pacts with investment banks. Janet Yellen, the head of the Federal Reserve, has warned that social-media firms are overvalued—and has been largely ignored, just as her predecessor Alan Greenspan was when he urged caution in 1999.
Good corporate governance is, once again, for wimps. Shares in Alibaba, a Chinese internet giant that listed in New York in September using a Byzantine legal structure, have risen by 58%. Executives at startups, such as Uber, a taxi-hailing service, exhibit a mighty hubris.
Yet judged by the financial yardsticks of the dotcom era there is as yet no bubble. The NASDAQ index of mainly technology stocks is valued at 23 times expected earnings versus over 100 times in 2000. That year Barron’s, an investment magazine, published an analysis showing that 51 listed technology firms would run out of cash within a year. On December 6th Barron’s repeated the exercise and found only five listed tech firms with wobbly finances.
Instead, today’s financial excess is hidden partly out of sight in two areas: inside big tech firms such as Amazon and Google, which are spending epic sums on warehouses, offices, people, machinery and buying other firms; and on the booming private markets where venture capital (VC) outfits and others trade stakes in young technology firms.
Take the spending boom by the big, listed tech firms first. It is exemplified by Facebook, which said in October that its operating costs would rise in 2015 by 55-75%, far ahead of its expected sales growth. Forget lean outfits run by skinny entrepreneurs: Silicon Valley’s icons are now among the world’s biggest, flabbiest investors. Together, Apple, Amazon, Facebook, Google and Twitter invested $66 billion in the past 12 months. This figure includes capital spending, research and development, fixed assets acquired with leases and cash used for acquisitions (see chart 1).
That is eight times what they invested in 2009. It is double the amount invested by the VC industry. If you exclude Apple, investments ate up most of the cashflow the firms generated. Together these five tech firms now invest more than any single company in the world: more than such energy Leviathans as Gazprom, PetroChina and Exxon, which each invest about $40 billion-50 billion a year. The five firms together own $60 billion of property and equipment, almost as much as General Electric. They employ just over 300,000 people. Google says it is determined to keep “investing ahead of the curve”.
Big firms are also making speculative bets, to add new products and insure themselves against technological change. Amazon is investing in content and recently acquired Twitch, a video-streaming firm. Google is throwing cash at driverless cars, robots and home thermostats. Facebook has acquired Oculus VR, a maker of virtual-reality headsets. Mark Zuckerberg, Facebook’s boss, has said that it will not have an immediate payback: “It’s going to take a bunch of years to get there.”
What are the odds of all this money being spent sensibly? Apple is still tremendously profitable. The other firms have patchier records. Google’s return on capital has halved to about 20%, after accounting for stock-option costs. Amazon has never generated much cash. The longer-term omens are not good. Few firms learn how to create a framework for spending tens of billions of dollars almost overnight.
When previous champions, such as Nokia, Yahoo and Microsoft, made big acquisitions in adjacent areas they often fared badly. There are few obvious sources of restraint at those firms still dominated by powerful leaders who control their companies: Google, Facebook and Amazon. All five of today’s stars have lots of excess cash. Much of this is parked offshore and cannot be brought home without incurring tax, giving an extra incentive to spend it.
The second area of technology froth is in private markets.