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So act that you use humanity, whether in your own person or in the person of any other, always at the same time as an end, never merely as a means - Immanuel Kant's Formula of Humanity

Sunday, May 12, 2019

Tech bubble 2.0 and the IPO Pins

I use the ride-hailing apps frequently. I pay them every time I close the meter. It is nominally priced and the driver also gets a significant profit too, for every ride. It is a win-win composition for both. It is very hard to imagine an awesome business idea like Uber cannot generate a profit so far in its multiple years of existence. It is also sad that a revenue generation model of ride-hailing apps, where every customer pays before getting off a ride - can be this screwed up. If you don't own any of the cars and any of the drivers - but just a mobile app that facilitate business between the demand and supply of a always waiting customer and a person with a car - Its just mediocre company performance. on any standards 

Before Uber hit the IPO this week, it was Lyft that hit the IPO market couple of months ago. It debut around the $78 mark and is now trading around $50 a share. Lyft lost $900 million dollars last year. The last earnings it reported after going public is yet another historic loss. Uber which wanted to hit the IPO with $120 billion valuation - started to see the week reception for Lyft and decided to rush to the market itself soon. The valuation went down every week and finally when the time came - it was $82 billion valuation. It was lot below the initial estimates. If they waited longer, the valuation of the company would go down even more and possibly the door would be shut completely even, if it decides to wait. Uber loses more money than lyft - they say its $900 million a quarter. Uber hit the IPO market at $45 and immediately traded down below $3. This really means the investor who bought it at the IPO were stung by public investors who got it for less. How Uber stocks performs needs to be watched.

When you buy a stock of the company, you are buying into the future revenue stream of the company. These new tech companies, in their IPO disclosure have explicitly mentioned that they may never be profitable. Pre-IPO investors have an exit strategy in the IPO usually. Founders and initial investors cash-in on the incoming public investors'  money. Why would anyone buy a share of a company that doesn't foresee a profit is beyond human rationalism. Only incentive is the demand for the share amongst the public - the belief that you can sell it to a bigger fool. As it turns-out - one day or the other, you run out of fools and then realize your were the last fool. 

Microsoft, Google and Facebook - other biggies went into the IPO market when they were profitable. However Amazon did not disclose a profit even after six years after going public. All these new tech companies planning its life as publicly traded entities - want their luck to work out similar to Amazon. They may not be as lucky. 

This is tech bubble 2.0

Paul Krugman, Nobel Laureate and Keynesian economist who has been strong advocate of Barack Obama's easy money economic policy and the Fed's approach with ZIRP and QEs after the 2008 financial crisis even admits there is a tech-bubble in silicon valley. The last time it happened in the late 90s, we all know it didn't end well. Investors lost money investing in new dotcom companies, that not only did not have profits, but did not even have sales. Many companies who went to IPOs lost all their money eventually and went out of business.

The recent tech-boom in the industry promises to be no different. We have the same set of companies coming to the IPO market with tall promises for the future but never made a profit in the company's lifetime so far. Pintrest IPO debuted this week. The company has been around for ten years. Never once, it made a profit. Talking about PINS (its stock ticker) - that breaks bubbles, it could very well be one.

If well-known companies like Uber, Lyft can fail miserably in their IPO debut, what is the motivation for other tech-startups that came into existence in the last few years? What is the mind set of the investors who are already behind those ventures? If I was an investor who has invested in multiple start-ups and see productive business model companies like Uber hit the dust in the IPO market - I will be really scared. I would like to exit my current investments and book my returns before things come biting. When all the investors rush to the exit - the whole start-up mania would starve for the funds. One thing we know very well in bust times is - when it goes bad, it goes horribly bad for everyone. If these highly hyped IPOs fail, it might act as a trigger for a genuinely anticipated slow-down that is already long overdue.

The bursting of the tech bubble will definitely be contagious. It will make the other asset bubbles burst including the housing, bonds (both sovereign and corporate). The corporate bubble in particular is almost 3 times what subprime was in 2008. A recession or slow-down would put the US economy into a long period of economic darkness. Trump and the Fed will do everything they possibly can, to avoid it until the markets hit a point - where whatever they do isn't relevant anymore. At the point, the public would know that the reality has finally set-in to the markets.