How I learned to stop worrying and love the crash

The tech sector is long overdue a correction – kick back and watch creative destruction do its thing

‘It has been raining money on fools for too long,” wrote Elon Musk last week. “Some bankruptcies need to happen.” The Tesla and Spacex boss can’t wait for the end of the tech bubble, and neither can I. If capitalism requires occasional periods of creative destruction – the idea made popular by Joseph Schumpeter that the old must be swept away for the better ways and companies to emerge – then the tech sector has lived a charmed life. Ordinary people suffered horribly from the 2008 financial crash. But for two decades tech was exempted from the boom-bust cycle, a pampered trustafarian living on an endless fund of easy money. Two decades – that’s a hell of a gap year.

Technology stocks have fallen sharply in 2022, and it no longer looks like a blip. Venture capital (Vc)-backed firms have lost almost half their value this year, according to Pitchbook, which tracks private company valuations. Last week, stars such as Tiktok owner Bytedance, Stripe and Reddit were among the companies that had their valuations slashed by a third by Fidelity Investments, again, only weeks after their last downgrade. The formerly prolific tweeter Marc Andreessen, whose VC firm had talked up blockchain as the cornerstone of what he called “Web 3.0”, has been strangely silent since the crypto crash last month.

“The process of reversion to a mean has begun,” says fund manager Ralph Jainz. A year ago in this column, he predicted that inflation would cause the tech bubble to pop. He is being proved correct. The “mean” he refers to is Prof Robert Shiller’s PE ratio, a 10-year inflation-adjusted measure of earnings per share. Historically, there have been three great peaks: in 1929, 2000 and a third that reached its high last December. For Jainz, that process of reversion is now well underway. Inflation causes interest rates to rise, which then wreck the delicate fiction of a young technology company’s discounted cash flow (DCF) model, on which its valuations are based. Rising interest rates mean future earnings don’t look quite so rosy.

Musk was making the point that too much money has been chasing too few good ideas. An overabundance of credit – for which we can blame central banks – has had two consequences, Jainz explains. “When money has no value, people will do stupid things with it. They will either buy assets they shouldn’t, or they may massively overpay for things.”

That affects both the good and the bad. Fundamentally sound companies, ones with real revenue and prospects, such as Microsoft, see their value fall too, and Musk’s own companies are no exception to the write-down. Tesla’s falling price has imperilled his ambition to acquire Twitter, and at the weekend he was forced to talk down plans to cut 10pc of the electric car maker’s staff. Furthermore, the future earnings of a big, brazen bet such as his Starlink venture – cloaking the world in satellite internet connectivity – look far worse from a DCF analysis too, now interest rates have risen.

In those two decades, the word “tech” itself became devalued: it hasn’t referred to technology or a technology company for quite some time. As recently as the 1990s it was easy to identify what a tech startup was. It would be a new company considered well-placed to take advantage of an innovation with a large potential future market. For example, when Nvidia floated, it was one of three companies to IPO (initial public offering) in a funding round of over 30, with investors betting the winner could take computer-generated imagery (CGI) to the masses, into PCS and games consoles. This needed technical knowledge and marketing skills. A bet like Nvidia was a risky one, as it should be, for incumbents usually won. But now “tech” has become so debased that another phrase has been coined – “deep tech” – to refer to anything actually related to engineering or computing. In the most exquisite sequence of Wecrashed, Apple TV’S romping dramatisation of the Wework story, founder Adam Neumann outrageously rebrands his office subletting company as a “tech company” solely to seduce Softbank’s Masayoshi Son, who is shopping for a “disruptive” platform. It works. Another of Son’s big bets, Klarna, now looks like the biggest potential casualty of the crash. To critics it is little more than a payday loans operation, only one tapping into a market of borrowers the credit market spurned, for the very good reason they make rather bad debtors: impulsive Gen Z-ers. Klarna is racing to an IPO as its valuation crumbles. Klarna was valued at $45.6bn a year ago, but had fallen to $31bn by February, and announced layoffs last month. Across the board, other ersatz “tech” companies in fast fashion are collapsing. I’d expect the food delivery companies to burst next, with consequences for commercial TV ad revenue, and the e-scooter market.

One of the oldest VC firms in Silicon Valley, Sequoia Capital, has now issued a gloomy 52-page prospectus for its startups with a name reminiscent of those nuclear fallout advice pamphlets from the Cold War, like Protect and Survive. In Adapting to Endure, the firm warns: “We do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery like we saw at the outset of the pandemic.”

That may seem a bit rich from the firm that once backed Google’s creepy spywear, Glass and which recently auctioned off a non-fungible token (NFT). But we are all better off when the silly money stops flowing, and to be honest, better off without the fools who shower cash at fools, like Sequoia.