28 May 2015

The dream economy


Doubtless you have heard of Uber, the online taxi-hailing service. Most likely you have heard of Airbnb. And Snapchat? Probably. Dropbox? Very likely. Spotify? Of course you have. Even if you haven’t used them yet they are sitting there on your smartphone, just waiting for the day when you suddenly find that you want whatever it is they offer.

But there’s more. What about Theranos? What about Zenefits? What about Cloudera, or Stripe, or Fanatics, or Jawbone? Strike any chords? How about Machine Zone, or Moderna, or Slack? How about Powa, Lyft, Houzz, Nutanix? How about MongoDB – come on, surely you have heard of MongoDB?

Well, maybe not. But since the name has come up, MongoDB is a technology start-up, in the business of database software. And just like all the other companies already name-checked, MongoDB is one of the more than 100 tech companies that have managed to raise enough money from investors to be valued at more than $1 billion before so much as issuing any public stock or revealing their income. As unlisted companies the sales and the profits they make are often secret, but the massive amounts of investment capital flowing into them are usually not so secret. Breaking the $1 billion barrier is far from normal even in the world of tech start-ups, but the fact that any start-up at all has attracted more than a thousand million dollars in cold hard cash is remarkable. It is part of one of the biggest new business booms ever seen. It is capitalism on speed.

According to Forbes the private tech start-ups that are valued at over $1 billion now add up to over $373 billion worth of investment, with some of those companies worth well over $40 billion. Most of them are US-based, although there are a handful of others in China, India, and the UK. Most of them have revenues of some sort, but revenues are not the same as profits: their expenses and investment costs eat up most or all of any potential profits. All investment contains an element of hope, but these are dream companies, built on pure hope.
Take Uber, the taxi-hailing service that is currently the most valuable of the unlisted US tech start-ups. Nailing down Uber’s revenues and profits is a matter of informed guesswork, but Business Insider reckons that despite the fact that Uber could have about $2 billion of annual sales by the end of this year, it is probable that the company remains unprofitable. Yet still the investment money comes rolling in.

Businesses that offer new ways of doing things that everyone does already – businesses like Uber – figure prominently on the list of big private tech start-ups. Transport, cloud computing, internet retail and mobile payments make up most of the dream economy. There are very few companies involved in making things, whether physical or entertainment products (in entertainment Vice Media and Legendary Entertainment are the only significant exceptions, and they are far from being the largest companies). The dream economy is very big on delivery systems, but very short on content to be delivered.

Yes, it is all strongly reminiscent of the dotcom boom and bust of the late 1990s, when for a while it seemed that any business plan could attract millions just by adding an ‘e-’ to its name. Just as in the dotcom bubble, today’s tech boom has created companies that seem exempt from the normal rules of investment. Valuations bear little relation to cash flows. Facebook (one online company that is stock-market listed and that therefore has to file public accounts) is trading at a price/earnings multiple of almost 80 (and not long ago it was around 200), when in the ‘normal’ economy any multiple of over 20 would make a company look rather expensive.

But the dream economy is not a normal economy. Investors are not putting money into factories or machines, or patents, or products. They are making bets – massive bets – on how people will behave in the future. Those bets may pay off. And if they don’t?

To answer that it is not necessary to look in the crystal ball – the book of history will suffice. The dotcom boom ended badly for many: the majority of the ‘new economy’ businesses simply disappeared – on the US Nasdaq exchange alone $5.1 trillion in wealth evaporated in the space of 20 months. A lucky minority of survivors – including eBay and Amazon – saw their market valuations fall by 90% or more before slowly recovering. And the dotcom bust ushered in a wider stock-market collapse that took years to play out: from 2000 to 2003 the FTSE 100 roughly halved, an even bigger drop than in the most recent financial crisis.

Yet there are some big differences from the dotcom bubble. Today’s tech craze is happening largely outside of public stock-markets. Contemporary tech investors are more likely to be venture capital or private equity funds, looking for the kinds of fast-growth businesses that are very hard to find among quoted companies.

And investment conditions today are very different to the late 1990s, when economic growth was hot and interest rates were around 6%. Today with interest rates effectively negative and the industrial economies growing very slowly, money has to work ten times harder to find a return. Investing in government bonds is a one-way ticket to bankruptcy, while quoted companies are currently expensive and almost certainly set for falling profits. Capital has to go somewhere, so increasingly it is going into ‘alternative investments’ like privately held businesses in the dream economy.

Another difference is the scale of today’s boom. Dotcom era investments were counted in millions, not billions. Even Facebook in its pre-stock-market days was not worth $1 billion. Today’s would-be technology master-businesses with their obligatory daft names and jazzy spellings tend to work on the ‘get-big-fast’ model – something that is actually possible now that smartphones and fast data connections are becoming ubiquitous and user networks are easy to build – and their funding requirements are correspondingly huge.

If all investment contains hope, all investment bubbles represent the triumph of hope over experience. When the current tech bubble deflates, the effects will be felt in the wider economy. Today’s multi-billion dollar dream companies will become tomorrow’s case-study footnotes. Most likely a handful of companies with real revenues (and that will probably mean actual transaction revenues, not those elusive forecast advertising revenues that feature in so many business plans) will survive the shakeout, and may even become dominant in their fields.

Maybe that means music streaming service Spotify. Maybe that means cloud storage system Dropbox. Maybe that means taxi-hailing Uber. Unless, of course, everyone is being taken for a ride.

Richard Walker is a journalist and communications advisor to financial companies.