Is Silicon Valley on the verge of disaster... again?

(map by Jay Simons)

It is traditional for moments of epiphany to involve bathtubs and evrikas, even though it doesn't happen all that often. Mine happened during an especially boring lecture. I was tempted to run around naked, evrika-ing at people, but I decided to keep the revelation in my pants err... self. To myself.

I had been reading news at random, a habit I had been keeping for boring courses for longer than I care to admit, and it struck me. Because sometimes, if you follow enough strands aimlessly, you start reaching the same miserable node, where they get hopelessly tangled. Eventually, enough jigsaw pieces you had no idea fit together become an image you weren't even intending to build, and, just for a few golden moments, the world presents itself on a platter with all the inevitability of a freight train. And you know you've just noticed something almost nobody else has, or, if they have, they're keeping it to themselves. 

My own version of evrika went something on the lines of: "Oh... shit. It's happening again, isn't it?"

Economists are mostly evil gremlins out to devour your soul, but occasionally they reveal their true fluffy nature of huggable chart-bearing human-sized teddy-bears. That's what happened when they settled on the name "economic bubble" for a phenomenon both scary and stupid. "So what's that?", I hear you ask through gritted teeth, knowing the answer'll sound boring.

Well, a bubble is basically a rather short period during which people leave their common-sense slippers inside and run out into the night barefoot, investing recklessly huge amounts of money into companies or other kinds of assets which aren't sensibly worth anywhere close to those millions. It is a kind of frenzy investors enter every now and then, when they get overexcited and temporarily forget the basic economic rules. As more and more investors sink fortunes into the objects of their adoration, they start rising in share value very quickly, so even more investors chime in, in the hopes of getting a slice of the sweet money pie that's snowballing down the hill, growing ever faster.

Invariably, the snowball reaches its maximum size, when it hits some inconveniently-placed jagged rock. Possibly a very large tree. Maybe a ski resort suntan parlor, I understand those are catching on for some reason. At this point, the investors either run out of money, or realise their investment isn't going to make any returns, and start dumping their shares. So, the market value of the whole sector plummets. The snowballing sweet moneypie crashes. The bubble pops. Bankruptcy is filed for.

Here is a TED-Ed video explaining it, which is also a nice segway to our next stop, the dot-com crash:

So it was that in the 1990's, after the Berlin Wall had finished its spectacular final act, the world was gripped by enthusiasm for the dawn of a new prosperous open era. Except for the Balkans. There are always some people that simply won't let go for all the wrong reasons.

Anyway, now that all those damn commies were finally not a problem, it was time to get down to the real good business. The World Wide Web swept around the... well, world, and western investors started taking notice. Money could be made on the Internet!

Well, yeah, but how much exactly? What's the realistic projection?

Nobody gave a shit. It quickly became common knowledge (practically all of which is wrong in any case) that on the Internet, the economy worked differently. The traditional measures of success, such as price-earnings ratio, or, umm, profits, were no biggy. What mattered was that the dot-coms, these website companies with the whiz kids at their helm, were going to change everything. And they were all going to become filthy rich in the process.

An insane few years followed, which saw VCs (venture capitalists) and investment funds throwing money by the shovelful at practically anything that had a '.com' at the end without so much as a second glance. Companies with no concrete or coherent business plan, let alone that had ever made a profit, were going public and racking up millions of dollars. That was further helped by extremely low interest rates. The idea was that your dot-com of choice would spread like wildfire and come to be used by thousands and even millions of people because it was for free. Then the company would eventually find a way to make money off the massive user base.

The Internet did change everything. But not a basic economic rule: if you ain't turning a profit, you're going bust, boy! And the bubble burst.

In 2000, all those valuations started plummeting, and most companies crashed. The Dot-Com Bubble was no more.

Along with it rode a smaller bubble. A bubblet, if you will. It was the broadband telecom bubble, which saw firms in the US and Europe get indebted by millions in order to build broadband lines and 3G networks at a pace way greater than it was sustainable. So they also crashed and burned.

Before leaving this mess of a cautionary tale behind, I just wanna point out that one of the largest
websites at the time and the poster child for the Dot Com Crash, Pets.com, thought this was a good idea:

Before the crash, there were omens of the disaster to come, but none as clear as the dogs performing oral on sock puppets.

Ew. Soggy.

But sometimes unintentional mistakes are made, right? It was a new market after all, people got hyped. Of course, now the industry has matured and, dumb as we are, we surely wouldn't be making the same mistake twice.

(April 2017)

Well, yeah, but overvaluation happens to some stocks sometimes, it'll contract back to proper size. Just because it's happening to Google it doesn't mean it's a trend.

(April 2012)

Oh, yeah, I remember that. A bit of an odd one.

Oh motherfucker.

But, I mean, those at least are pretty well established companies with clear revenue.

(March 2017)

Son of a whore.

Actually, how've Snap's shares been hanging since March?

(July 2017)

Snap might as well have been a bubble all on its own.

But these are the kinds of signals I've been picking up in the past year. And even though a bubble is hard to detect before it bursts, it's certainly looking rounded, wobbly and soapy from down here. 

But before jumping to conclusions, let's pull up some numbers. If you're bored only by the look of the following section, I get ya. Feel free to skip it if you want, but there'll be some commas and complicated fiscal terms crying after you.

Apple Inc. is valued, as of July 13 2017, at about 771 billion USD, with annual profits in 2016 at $45.7 billion, a decline in profits of 14% since 2016. Its quart revenue is at $52.9 billion for the second quarter of fiscal 2017. 

Alphabet Inc. a.k.a. Google with a worse name is currently at a market cap of $662 bn, with profits for 2016 at roughly $19.5 billion.

Facebook, a.k.a. voluntary Stasi, is right now at a market cap of $461.5 billion, with profits in 2016 of $10 billion.

Microsoft is right now valued at $554.1 bn, with net income in 2016 of  $16.8 billion.

Amazon is at market cap $478.2 billion. But with profits it gets a little more complicated. For years, Amazon operated at a loss. More precisely, from 1995 to 2002, in 2000 losing a record 1.4 billion in the dot-com bust. Then, it started making money, albeit not a lot. Except for 2012 and 2014, when it lost money again. Right now their profits seem to be skyrocketing, at least in comparison to the past, to $2.3 billion in 2016, in great part owing to their cloud service. 2016 was the second year the company managed to exceed $1 bn in net income, the first having been 2010. But you have to take into consideration those profits are there despite revenue (money received before paying their employees and stuff) of almost $136 billion.

Twitter is valued at $14 billion. It has never made a profit. And, to be fair, it's been devaluing in stock price for a few years now. It's also got other problems, such as chief executives leaving in swaths.

I'm not even getting into Snapchat. It got a ridiculous market cap despite no profits. Now it's dropping just as fast.

Pinterest hasn't gone public yet, but it's got a $12 billion valuation. Of course no profits, that's not how Silicon Valley works, even though it's got revenue in the hundreds of millions.

Uber is valued at present at $69 billion. However, it's losing money at an impressive rate. Despite $20 billion worth of bookings in 2016, it lost $2.8 billion.

Yelp has a market cap of $2.5 billion. It's been reliably losing money for years. For example, in 2016 it lost $4.6 million.

Even poor old Blackberry, who's been subject to turned backs from customers for several years and gave up making phones and went to cry, has a market cap of $5.2 billion. It's been losing money for 5 years straight. 

Spotify hasn't gone public, but it's valued at $13 billion. Once again, it's been losing money since the beginning.

Pandora, a similar service with a market cap of $2.2 bn, lost $343 mil last year.

Speaking of music: Shazam, an app I think is fucking brilliant, is valued at over $1 billlion. Numbers are hard to come by, but after operating at a loss for years, it says it's finally turned a profit in 2016.

TripAdvisor has a market cap of $5.3 billion, a third of what it was 3 years ago. At least it made $120 million in 2016, altough profits have been declining.

Tesla's market cap is at $53.1 bn. It was briefly the most valuable car brand in the US, exceeding GM in stock value, but it sank back a bit. It's still got almost the same value as GM, and that's considering that Tesla has been losing money for years, whereas GM is making billions.

Alright, I'm bored. Let's wrap up the databonanza.

The thing is, I've been wondering for years how these tech companies are making such staggering amounts of money. I only now got around to checking, and it appears the answer is nowhere as ingenious as I had thought: they aren't. They aren't making money. Some are making profits that are nowhere near their stellar valuations, but most are losing money and living on investor cash.

Of course, I also know how those that are turning profits are doing it. Apple's selling overpriced iStuff, Google's selling some hardware but mostly your data. Facebook is selling your data too, somewhat more intrusively as far as I've seen. Microsoft is both in the hardware and selling data business. Amazon sells stuff and cloud space and sometimes your data. The others are attempting variations on that as well. (Twitter, for example, is trying to attract video creators on the platform via a monetization scheme.) 

As long as you speak no more than 140 characters, you may apply.

I would just like to point out here that the selling-your-browsing-data business is estimated at around 130 - 200 billion dollars. Food for thought. But the discussion on privacy is another subject for another time. 

Quick sidenote, speaking of making money on the Web: in spite of the huge profits of the likes of Google from these sources, I've noticed in recent years more and more small Internet creators complaining about sinking ad revenue, from online newspapers to websites such as Newgrounds. I find this sort of paradoxical and very very interesting, and it appears to come as a result of the rise of AdBlock. So creators have turned to alternatives, such as Patreon or tips and subscriptions on Twitch. However, there is another lesser known way that I recently discovered, and I think it's really smart: a thing called Flattr. Basically, you give it a monthly budget, and then you can tip through it websites you visit. When the money is done, it's done, and you get to support your favourite creators.

I thought it's great, in any case.

No, The Chapsterhood isn't sponsored by Flattr. I fucking wish.

Back to the matter at hand.

As I've said, the Internet changed everything. It brought free access to almost unlimited information, put several industries in jeopardy and, most importantly, porn. Yet a lot of it rests on the shoulders of a small number of companies, who, for all their good intentions, seem flimsier the closer you take a look. They are called the unicorns: the once-in-a-lifetime investment opportunities who disrupt (this is a word the Valley loves) everything. They just swoop in and take the world by storm and make a billion dollars before their gluten-free breakfasts. Google. Facebook. Amazon. Apple. Microsoft. And dozens of smaller ones. 

No, not you.

Yet it appears a few people are waking up to the fact that, perhaps, this frenzy of spending billions on companies that aren't making a profit, nor aren't gonna, or are overvalued and stretch their resources on risky but potentially huge bets such as Facebook's Aquila, Google's crazy-spending X division (which has admittedly got amazing results over the years) or Amazon's drone delivery flying warehouse ... I'm sorry, I just have to stop and point this out : FLYING. FUCKING. BLIMP. WAREHOUSE. ABOVE THE CITY. ... maybe, just maybe, this whole investment frenzy encouraged by low interest rates once again, like in the 90's, that's only accelerating, isn't going to last.

Amazon falling stocks aren't just words.

I don't pretend to even begin to understand the underlying complexities of today's stockmarket, that's primarily driven by AI in any case, but, as a rule, if something appears too complicated, somebody's probably profiting from making it obscure. I see no reason why a simple old truth doesn't hold here: No profits won't last a company long.

I'm not saying Silicon Valley hasn't delivered on many innovations it has promised. Oh, it did. And it'll continue to for as long as this goes. But it'll burst. That's what bubbles do.

There are voices who bellow to all who ask that this isn't the same as then and there's no worry. It's just a different economy altogether. The economy of the unicorns! It doesn't subscribe to usual economic stupid restrictive backwards thinking! And still, somehow, it appears that all who support this as perfectly normal stand to gain something from it. Just a thought.

Of course, something radical might change yet again in the world soon. It seems to be happening such an awful lot these days. But, until further notice, what looks and smells and sounds like a bubble and under analysis appears to have certain bubble-like qualities is a bubble.

And I'm not quite the only one who noticed. Some think that it's way worse than the dot-com bubble, what with the worse economic footing. Paul Cohn, an investor, made a very good point in Forbes:

             "Unlike the dotcom bubble where much of the value was in public stocks when the bubble burst, this time around we have built much of the unsustainable value in private company stock - the "Unicorns" that boast valuations in excess of $1 billion. I'm not a public stock analyst but overall stocks are not trading at outrageous P/E ratios.  Unicorns are. At some point, the Unicorns need to go public to provide their investors with a return on their investment. Some could be sold but at a certain valuation this becomes difficult. The Unicorns are growing their top lines very aggressively which is a positive. They are raising and burning a lot of money to do this. They ultimately will need to show a path to baseline profitability with attractive margins to justify their valuation. I'm skeptical that a lot will be able to do this.

            The tech bubble will burst. I think it is somewhat protected in the near term because the bubble hasn't spilled into the public markets in a material way. But it will burst - that's what bubbles do."

Here's somebody else who noticed:

           "Last month Robert Bouroujerdi, chief investment officer at Goldman Sachs, and most definitely someone who does remember the last dotcom boom, published a report in which he cautioned of the growing risks presented by the meteoric rise of the Big Five tech behemoths: Apple, Amazon, Facebook, Alphabet and Microsoft.

Bouroujerdi noted that in the year to the start of June, these companies added a total of $600bn of market capitalisation – the equivalent of the gross domestic product of Hong Kong and South Africa combined. Parallels to the 1999-2000 crash are becoming increasingly evident, he said.

The note roiled the market, giving us a taste of just how nervy some of the investors in these companies are becoming. Apple shares fell 4 per cent, swiping about $30bn off the market capitalisation of the world’s most valuable company, and this was a relatively moderate warning. Just think of the impact a more harrowing premonition might have had."

In fact, during my research I started understanding that, altough few people call it out, many in Silicon Valley know it's a bubble. They just have no interest in admitting it. 

Some are probably in denial. I dunno.

Then again, if the AI Revolution delivers, it won't matter.

But that's not the point. Where there's a bubble, there's money to be made, and that's exactly what they're doing. Most of the unicorns are going to be unicorpses, just like in any other economic disruption period in history, but the few who survive this are going to be huge. They'll emerge as the dominant companies of the era. They will be the Bell of the 21st century. And it's starting to become clear who that is, but it's not quite a safe bet just yet. The investors in those few are going to be the tippy top. The rest aren't gonna have that much of a problem. They're already rich anyway. But all the engineers and the little guys, they're in trouble.

But don't take my word for it. Take it from a start-up consultant who spoke to the Guardian back in 2015:

“Look at how many companies are cash-negative. Twitter is still cash-negative. Even Uber is cash-negative. Silicon Valley is a hype machine. That’s how it works. And sometimes if there’s enough hype, it pays off. And sometimes it doesn’t. It’s like when you go house-hunting and the real estate agent doesn’t say, ‘Look at how great the space is. Look at how great the area is.’ They say, ‘If you don’t buy now, it’ll be twice the price in six months’ time.’ It doesn’t reflect true value. It’s just a sort of herd mentality.

 Of course it’s a bubble. Everyone knows it’s a bubble. Which doesn’t mean that a lot of people won’t make a lot of money. It’s like musical chairs. The question is not if it’s a bubble, but will it remain long enough for us to get in on it? The question is: am I too late?"

It's not gonna last. But then, what does?

_____________________________________________________________

That's not to say that economic bubbles are all bad. They stimulate economic growth and innovation at a rate and scale that'd never happen in a sustainable, sensible way of doing things. Or as Daniel Gross puts it in his book Pop! Why bubbles are great for the economy:

"If you take the long view … it’s possible to detect a pattern that emerges in bubbles and their aftermaths. Especially bubbles that leave behind a new commercial and consumer infrastructure. With apologies to Oliver Stone, these bubbles, for lack of a better word, are good. These bubbles are right; these bubbles work. Thanks to the American penchant for creative destruction and the U.S. bankruptcy system, investors — and the economy at large — tend to get over bubbles quickly. … The stuff built during infrastructure bubbles — housing and telegraph wire, fiber-optic cable and railroads — doesn’t get plowed under when its owners go bankrupt. It gets reused — and quickly — by entrepreneurs with new business plans, lower cost bases, and better capital structures. And when new services and businesses are rolled out over the new infrastructure, entrepreneurs can tap into the legions of users who were coaxed into the market during the bubble. This dynamic is precisely what has made Google the “it” company of this decade …

Looking back, many similarly iconic companies and industries that have stimulated economic growth, and that helped define America’s commercial culture, were either formed in those hothouse bubble environments or can trace their origins to their aftermaths. Consumer packaged goods and mass retailing, data services and mass media, the vast financial services sector, tourism, telecom, and what venture capitalists still call “the Internet space.” Sears, the Associated Press, Western Union, Fidelity Investments, Google — they may all have developed anyway. But they certainly would not have developed as they did without the Pop! dynamic."

It's not all bad.

Pop.