May 16, 2021

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A clear sign of the tech bubble

4 min read


This week, for a brief moment, tech stocks fell, and a generation of entrepreneurs were offered a glimpse of their own mortality.

The brief drop accompanied a wider market swing. At the very least, it was a reminder that a reset was long overdue after a year-long rise in tech stocks. Even Tesla’s slide, which was down about 18% from its peak a month ago, is not yet big enough for the stock to reach what is considered territory. bearish market.

More than just a sign the market needs to let off steam, however, the quake reminded that capital will not always be so easily – and cheaply – available.

When cash is plentiful, the tight alignment between Wall Street and Silicon Valley can seem almost unbreakable. Tech start-ups that promise to change the world offer a big picture for investors eager to find a reason to believe. Conditions like this favor so-called “story stocks” – businesses that can simply tell about a huge new market opportunity.

A classic of the genre is the electrification of personal transport. This week’s additions to the dream of a world beyond combustion engines include the $ 4.6 billion flowing in Luxury electric car maker Lucid Motors and the $ 1.6 billion raised by future Joby Aviation air taxi service.

Despite the obvious risks when a wave of capital infiltrates tech start-ups, there are benefits. This can, for example, help bring new technologies into the mainstream: the tech and telecommunications bubble at the turn of the century may have resulted in enormous financial waste, but it has funded communication networks and technology. digital infrastructure to support the next generation of the Internet. companies.

It also means that promising technologies are no longer at risk of being underfunded – although simply providing cash will not bring them to commercial viability faster. Battery technology has taken many years to keep up with the cost curve. The fact that billions of dollars are suddenly available cannot accelerate this process. Yet, Wall Street’s financial vehicle of the day for funneling money to tech start-ups – special purpose acquisition companies that raise cash and then seek out a promising company to merge with – comes with two very big warning signs.

The first is that, in this new form of stock market-funded venture capital, windfall profits can flow to promoters and speculators long before new companies prove their commercial viability. Traditional venture capitalists typically don’t see a profit or have the ability to sell for years.

The various incentives built into Wall Street’s version of VC are exemplified by the Lucid deal. On paper, the Spac involved has already made an 87% profit on its investment just for making a deal. And its promoters, who paid a grand total of $ 25,000 for their “founder’s shares,” are sitting on a stake with a market value of $ 1.5 billion.

Spac also provided a vehicle for wild speculation. Its publicly traded shares had already increased more than fivefold in anticipation of a deal, before falling by nearly half.

There are certain mechanisms to encourage a longer-term view, for example by placing limits on how quickly Spac promoters or follow-up investors can cash in. But the 18-month blockade of Lucid Spac’s founders is nothing compared to the many years that traditional VCs often have to wait to see a comeback.

The second concern is that the current close alignment between investors and entrepreneurs is unlikely to last. Financial conditions will change. Even with many years of flawless execution of the promises made by start-ups, it will be difficult for new companies to sustain their current valuations.

Unlike companies that come to Wall Street through a traditional initial public offering, Spacs promises revenue up front. Joby says he won’t make any sales until 2024, but will then hit $ 2 billion in revenue in five years. Lucid, which hasn’t launched its first vehicle, predicts annual revenues will rise to above $ 20 billion within five years – a figure Tesla only surpassed in 2019.

These promises support heady evaluations. Lucid, on paper, is estimated to be worth $ 24 billion. Tesla only got there after five years of building and selling cars and a year after its groundbreaking Model S hit the road.

The world may be on a path to more electrification, with luxury cars like those made by Lucid and air taxis like those operated by Joby, an important part of a clean energy future. But when times change on Wall Street, many investors may no longer have the patience to shop around.

richard.waters@ft.com



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