Is the tech bubble just filled with hot air? | FT Alphaville

Is the tech bubble just filled with hot air?

The entertaining Economist debate between Steve Blank and Ben Horowitz, on whether we are in the early stages of a tech bubble, has ended, with closing statements published Wednesday.

The transcript of the full debate runs long, so in addition to recommending that you read the whole thing we’ll just focus on a couple of stand-out points.

Blank opened the debate by showing this graph, which is based on the academic work of Jean-Paul Rodrigue, arguing that we’ve just entered the “Mania” phase…

… which he describes thusly:

We have just entered the mania phase. The Linked-in IPO valued the company at $8.9 billion at the end of the first day of trading. It sent a signal that there is an irrational demand for tech IPOs. Silicon Valley startups are falling over each other to file their S-1 documents to go public.

Some precursors to the bubble happened when Chinese Internet companies listed on United States stock exchanges. In December 2010, Youku—the YouTube of China—went public, with a valuation of $4.4 billion at the end of the first day (on $58.9 million in 2010 sales). In May 2011, RenRen—the Facebook of China—had a first day valuation of $7.4 billion (on $76.5 million in 2010 sales).

Dr Rodrigue’s description of what happens next sounds familiar: “the public jumps in for this ‘investment opportunity of a lifetime’. The expectation of future appreciation becomes a ‘no brainer’…Floods of money come in creating even greater expectations and pushing prices to stratospheric levels. The higher the price, the more investments pour in. Unnoticed from the general public, the smart money as well as many institutional investors are quietly pulling out and selling their assets…Unbiased opinion about the fundamentals becomes increasingly difficult to find as many players are heavily invested and have every interest to keep asset inflation going.”

“The market gradually becomes more exuberant as ‘paper fortunes’ are made and greed sets in. Everyone tries to jump in and new investors have absolutely no understanding of the market, its dynamic and fundamentals…statements are made about entirely new fundamentals implying that a ‘permanent high plateau’ has been reached to justify future price increases.”

We are seeing this bubble unfold by the book.

Horowitz responded by arguing that public valuations of tech companies are actually quite reasonable — or perhaps even outright cheap:

And as for the valuations of privately traded companies, writes Horowitz, it’s hard to make a judgement because — by definition — we lack publicly available information. Maybe a tech bubble will eventually inflate, but at the moment things are more 1995 than 1999.

Both experts present theoretical ideas that seem a little too neat to us, and there was a bit of talking (err, writing) past each other — with Blank arguing that upcoming IPOs were expected to price at ridiculous multiples, and Horowitz countering that public tech stocks were inexpensive and that shares of recent IPOs have already started falling. It seems to us that both of these cases can hold simultaneously.

But the most interesting argument from Horowitz had to do with his rationale for why this time is different (that phrase again) from the late 90s:

History shows that major technology cycles tend to be around 25 years long with the bulk of the purchases occurring in the last five-to-ten years. This has to do with adoption rates; this period seems about right for the oldest cohorts (less likely to adopt new technologies) to die off and for younger cohorts (quickest to use new technologies) to enter the market. …

Let us look at examples of the last two major computing cycles (prior to the Internet).

Now let us look at where we are with respect to the Internet adoption cycle.

As you can see, we are poised to hit the major adoption wave for the Internet technology platform over the next 8 years. …

With costs 100 times lower, programmer productivity ten times higher, and the market 50 times larger, it stands to reason that many more internet businesses will work today than did the last time around.

As we said, both arguments are quite theoretical, and all of this falls well outside the range of our expertise, so we won’t even venture a guess as to who is right — or if they’re both wrong.

Instead we’ll end with a thought from Horowitz that’s also crossed our minds lately (emphasis ours):

It turns out that there is plenty of fear in today’s financial markets in general, and in the technology market in particular. Stocks are at their lowest point in two decades, and technology stocks are at an all-time low vs. industrials. I imagine the readers of The Economist are leading thinkers on these matters, whose advice and inclinations will likely be followed by the larger population. As of this writing, 68% of the people who voted in this debate believe that we are already in a bubble. If 68% of Economist readers, and their followers, do not believe that prices will rise indefinitely, then it stands to reason that prices will not rise and, low and behold, they have not. We should not be surprised by the Incredible Sinking Bubble, because it is not really a bubble at all. In fact, it is just the opposite: the balance has swung so far to the fear side that people believe we are in a bubble even though we are in a boom.

We’re especially curious about this now that post-IPO investors in some of the newly listed companies have taken big hits.

So a closing question for our readers, especially the tech-savvy among you and those better versed than we are in previous manias: can a bubble inflate if so many people are worried about a bubble inflating?

Related links:
This house believes that we have entered a new tech bubble – The Economist
How to write about the Groupon IPO when you don’t really care – FT Alphaville
Here comes Renren – FT Alphaville