SIGNS OF A BUB­BLE?

Rise of high- val­ued start- ups is stok­ing fears of an over­heated tech sec­tor

Los Angeles Times - - MONDAY BUSINESS - By Dean Stark­man dean. stark­man @ latimes. com

John Backus thinks the public pays too much at­ten­tion to uni­corns, and he’s not re­fer­ring to the leg­endary an­i­mal.

The founder of ven­ture cap­i­tal f irm New At­lantic Ven­tures in Re­ston, Va., is talk­ing about start- up tech f irms that are worth more than $ 1 bil­lion and haven’t even gone public yet. They’re known in the tech busi­ness as uni­corns for their sup­posed rar­ity.

Start- ups such as Snapchat Inc. in Venice and Uber Tech­nolo­gies Inc. in San Fran­cisco have higher val­ues than many For­tune 500 com­pa­nies, but Backus said a few high- val­ued start- ups rep­re­sent, at most, a “bit of a val­u­a­tion bub­ble” among es­sen­tially sound busi­nesses.

Plus, the en­tire ven­ture cap­i­tal busi­ness sup­port­ing the tech sec­tor rep­re­sents such a small slice of the f inan­cial land­scape, he said, that even a to­tal col­lapse wouldn’t harm the broader econ­omy as it did when the tech bub­ble burst in 2000.

“We’re over- fo­cused as a coun­try on uni­corns,” he said. “Even if we [ ven­ture cap­i­tal­ists] were to­tally stupid and it all went to zero, it wouldn’t re­ally move the nee­dle.”

The rise of a new class of U. S. cor­po­ra­tion — star­tups with out­ra­geously high val­ues — and an inf lux of ven­ture cap­i­tal have stoked fears about whether an ex­u­ber­ant tech sec­tor is over­heat­ing once again.

Shares of pub­licly traded tech­nol­ogy com­pa­nies are up nearly 13.5% in the last year through Fri­day, easily sur­pass­ing the broader Stan­dard & Poor’s 500 in­dex, which gained 7.7% in the pe­riod, ac­cord­ing to Fac­tSet Re­search Sys­tems Inc.

Mean­while, pri­vate mar­kets con­tinue to pro­vide an- ec­do­tal ev­i­dence of even more dra­matic gains.

Uber’s worth, for in­stance, jumped 119% to $ 40 bil­lion in De­cem­ber from $ 18.2 bil­lion last June, ac­cord­ing to Dow Jones Ven­ture Source.

And the in­dus­try’s latest ini­tial public of­fer­ing tended to jus­tify the high pri­vate val­ues. Wearable tech f irm Fit­bit Inc. in San Fran­cisco started trad­ing Thurs­day, and the stock soared more than 50% above its $ 20 IPO price to $ 32.50 by Fri­day’s close, valu­ing the com­pany at $ 6.5 bil­lion.

Even so, some be­lieve a bub­ble is brew­ing in the pri­vate mar­kets, at least.

“When al­most ev­ery­one who in­vests in an as­set class should write their in­vest­ment down to zero the day af­ter, that’s a bub­ble,” said Mark Cuban, who made his for­tune in the dot- com era with broad­cast. com.

New in­vest­ments into ven­ture cap­i­tal funds jumped to $ 30 bil­lion last year from $ 17.7 bil­lion a year ear­lier, ac­cord­ing to the Na­tional Ven­ture Cap­i­tal Assn., a Washington trade group.

In­vest­ments by ven­ture f irms in start- ups hit $ 49.3 bil­lion last year, up from $ 30.1 bil­lion in 2013. Most of the dol­lars have been f low­ing to the big­gest start- ups, in­clud­ing the so- called de­ca­corns worth $ 10 bil­lion or more, ac­cord­ing to Ven­ture Source.

Be­sides Uber, they in­clude video mes­sag­ing f irm Snapchat, worth $ 16 bil­lion by its last f inanc­ing round, and lodg­ing com­pany Airbnb Inc. in San Fran­cisco, val­ued at $ 13 bil­lion. Fi­nanc­ing rounds now un­der­way will most likely send val­ues of such com­pa­nies higher.

In all, the ven­ture cap­i­tal in­dus­try had $ 156 bil­lion un­der man­age­ment at the end of last year, com­pared with $ 143 bil­lion in 1999, the year be­fore the dot- com crash.

A big worry for skep­tics of the pri­vate mar­ket is its very pri­vacy.

Un­like public com­pa­nies, pri­vate f irms are not re­quired to dis­close f inan­cial in­for­ma­tion, leav­ing the public to as­sess val­ues based only on what­ever in­for­ma­tion the com­pa­nies choose to dis­close or leak into public view.

Crit­ics of the in­dus­try ar­gue that such opac­ity is dan­ger­ous be­cause busi­ness mod­els are untested by, and in­vis­i­ble to, public mar­kets. Cuban said that at some point, sky- high val­u­a­tions can lead to pri­vate com­pa­nies play­ing fi­nan­cial games, such as grant­ing ad­di­tional con­ces­sions to new in­vestors in re­turn for in­creas­ingly high head­line val­u­a­tions and cre­at­ing an il­lu­sion of value.

“Ev­ery­one has one or two ‘ real com­pa­nies’ with real rev­enue and even earn­ings, just like there were real com­pa­nies in the tech bub­ble,” Cuban said.

“The is­sue is this: If you raise [ money] at too high a val­u­a­tion, and your busi­ness is not grow­ing quickly or you don’t hit the bench­marks you promised in­vestors, then you have to play games with fu­ture in­vestors,” he said.

“Each suc­ces­sive VC takes ad­di­tional rights from the ear­lier in­vestors. The early ones agree be­cause they know that if they don’t, the com­pany dies.”

Cuban con­cedes that even if risks are grow­ing in the pri­vate mar­kets — and many be­lieve they re­main small — the spillover ef­fects to broader mar­kets are likely to be con­tained.

For one thing, stocks of pub­licly traded tech­nol­ogy com­pa­nies are trad­ing nowhere near dan­ger lev­els, said Scott Kessler, a tech­nol­ogy an­a­lyst at SP Cap­i­tal IQ. He noted that tech com­pany shares are priced at 16.8 times pro­jected earn­ings, lower than the broader mar­ket, which is trad­ing at about 18 times.

“The con­ver­sa­tion is re­ally a non- starter in [ pub­licly] listed tech, es­pe­cially ma­ture tech where we are fo­cused,” said Tushar Ya­dava, iShares in­vest­ment strate­gist at New York’s Black­Rock Inc. “Ma­ture tech is one of the cheap­est sec­tors in the mar­ket.”

Ven­ture cap­i­tal f irm An­dreessen Horowitz made an In­ter­net splash last week with a 53- screen slide show ar­gu­ing against the ex­is­tence of a tech bub­ble to­day, public or pri­vate.

It noted, for in­stance, that over­all tech in­vest­ment was only 2.6% of gross do­mes­tic prod­uct last year, com­pared with 10.8% in 1999. Mean­while, the online mar­ket has ex­ploded, with ecom­merce rev­enue at $ 304 bil­lion last year com­pared with $ 12 bil­lion in 1999.

New At­lantic’s Backus said that the rise of uni­corns and other start- ups rep­re­sents a fun­da­men­tal shift in the way com­pa­nies are funded, not a bub­ble.

With ven­ture cap­i­tal fund­ing plen­ti­ful, he said, founders and in­vestors are keep­ing com­pa­nies pri­vate longer and let­ting them grow larger to reap much of the gains in value that used to go to public share­hold­ers af­ter ini­tial public of­fer­ings.

“What’s changed is the re­la­tion­ship be­tween public and pri­vate mar­kets,” Backus said. “Pri­vate com­pa­nies are stay­ing pri­vate be­cause they can.”

In­deed, ven­ture fund­ing is ris­ing, but tech- re­lated ini­tial public of­fer­ings are down 47.4% this year through June 10 to just nine, com­pared with 24 dur­ing the same pe­riod last year, ac­cord­ing to merg­er­mar­ket. com.

With the public mar­kets on the side­lines, Steven N. Booth, a pro­fes­sor of entrepreneurship at the Univer­sity of Chicago, said risks in the pri­vate mar­ket re­main largely con­fined to the in­vestors them­selves.

“Val­u­a­tions are frothy. I would not be sur­prised to see a num­ber of uni­corns de­cline in value,” he said. “The risks are not com­pa­ra­ble to those in the tech boom of 2000, at least not yet. That could change if in­vest­ment con­tin­ues or picks up.

“You can think of to­day,” he said, “as look­ing more like 1998 than like 2000.”

Lionel Bon­aven­ture AFP/ Getty I mages

SNAPCHAT, a video mes­sag­ing f irm, was worth $ 16 bil­lion by its last f inanc­ing round and its value is ex­pected to go higher.

Richard Drew As­so­ci­ated Press

FIT­BIT I NC. in San Fran­cisco started trad­ing Thurs­day, and the stock soared more than 50% to $ 32.50 by Fri­day’s close, valu­ing the com­pany at $ 6.5 bil­lion.

Ross D. Franklin As­so­ci­ated Press

UBER’S WORTH jumped 119% to $ 40 bil­lion in De­cem­ber from $ 18.2 bil­lion last June, ac­cord­ing to Dow Jones Ven­ture Source.

Airbnb

AIRBNB, the San Fran­cisco- based home- shar­ing com­pany, is val­ued at $ 13 bil­lion, mak­ing it one of the elite start- ups.

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