I’ve been alive during multiple successive waves of IPO mania in the “high tech” stocks but this latest wave does surprise me. The bust is coming before the boom as witnessed by any of the recent IPOs but most clearly from Groupon as this, one of many, article and this show.
Before the 1990s dotcom boom, startups, at least those labeled as high tech, actually had to invent some technology that people actually would pay for (free stuff is a hard way to make a profit) and they actually demonstrated their business model worked by some non-cooked financial statements showing multiple quarters of real and increasing actual profits. But that was too old-fashioned and slow to reach zillionaire status so in the 90s the world got creative and figured out how to sell worthless stock based only on promises.
But during the 90s companies found they could sow magic beans and collect “eyeballs” (in lieu of actual revenues), claim hockey stick growth curves, pull some sneaky tricks of stuffing the pipe before the IPO, offer their worthless stock to the public, double in the first few days, fake their first few earnings statements, and then go bust.
But watching this new “boom”, more at a distance this time so I only get the hype and not the inside stories, a new model has been invented. In one experience I had of shopping around a business plan to the few early stage VCs I actually got to hear what the scam was. After listening politely to our plan they informed us that VCs don’t make any products (and don’t really care about products) and don’t collect any revenue; instead they are in the stock selling business. Stock is just a commodity like anything else. It is worth what someone will pay for it. VCs could care less about the business plan because they’re only listening to (or visualizing in their heads) how the IPO pitch is going to work and will they be able to shake money out of the pockets of credulous farmers in Kansas. So the 90s boom was all based on the idea that someone would believe economics laws had changed, via the magic of the Internet, and any conventional wisdom about old-fashioned profits was now merely replaced by growth in clicks. If your business plan could show exponential growth in eyeballs it was assumed somehow that translated into actual revenues.
Well, that emperor had no clothes and so the whole thing came crashing down, soon to be replaced with selling worthless securities based on loans to people who had no chance of paying them back, but with a bunch of Sloan School magic math that showed actual ability to repay loans had nothing to do with pricing a security, until, of course, that Ponzi scheme collapsed. So what to do next to stick your hand in the pockets of hard-working people?
The first decade of the 21st century was so dismal, what with wars of choice paid for off-budget that new startup activity had a hard competing with that Ponzi scheme, plus Goldman Sachs was stealing every dollar not in lockboxes with their “shitty deals” that had the shiny gold plate of all that silly “rocket science” math and hard sell by the superstars of finance who’d come down from their ivory tower to mingle with your slobs, if you had some money.
But after 2008 it seemed the ability to steal investors money based on toxic securities had been exposed by the need for massive bank bailouts (the banks fooled themselves and either ate their own dogfood or got stuck with unsold inventory), so that’s where all the scam artists are left today. Ah-ha, let’s create social media, everyone wants to talk to everyone else so the eyeball count can soar even faster than eToy and surely we can convince everyone, one more time, that eyeballs somehow translate to capital gains on IPO stock.
But this time I think it was different because we added a couple of new levels in the investment model, thus creating a perfectly good old-fashioned proven model of multi-level marketing, the pyramid scheme (not to be confused with the oh-so similar Ponzi scheme). So we find a couple of kids, college dropouts preferred, who can still get away with living in their parents’ basement and give them a tiny piece of money (aka an incubator) so they can rent a shared server for $10/month and hack together some PHP code to create, viola, a “high tech” business that will soar to undreamed heights of avarice.
If this part worked then we could enter the next level of the pyramid, suck out some investment capital from angels and other “early-stage” investors to buy in at 10X the initial stock valuation (with the original investors already cashing in some of their shares so they could get an apartment). Just enough money to upgrade to the Amazon cloud and maybe fix some of the bugs in the hackathon code base they’d created. What money was left could then go in massive promotion to start sucking in those eyeballs. And of course since your “stock” has already gone up 10X you can easily hire all those unpaid interns to create more crappy software in caffeine and drug fueled hackathons.
Now they could enter the next stage, traditional venture capital. Now one parallel event in finance was that people with money, like pension funds and insurance companies, if they hadn’t lost it all to Goldman Sachs, couldn’t make any return because the Fed obligingly dropped interest rates to zero so any “safe” return was 0.03%, not exactly enough to meet all the defined-benefits obligations. So once again the dumb money was shopping for higher yield investments and money poured into venture capital funds. Anyone who knew five money managers could create a fund over night. Again, once upon a time, I was briefly engaged as a consultant to exactly such a person, someone who knew how to raise VC money but had no clue how to actually invest it! All the feeder funds for Bernie Madoff demonstrate that raising investment capital and investing it are two completely different skills so all the Sand Hill Road crowd had a problem.
Now most VCs have relatively little staff and few partners so they just don’t have the time to look at many deals. So with bathtubs of money pouring in, collecting 0.03% while sitting uninvested, they need to make deals fast. And small deals won’t cut it, now it had to be tens or even hundreds of millions after the lunch at Buck’s. So the first two levels of investment in the pyramid could sell out to the new money and create more stock to soak up all that VC money.
But we’re not quite out of levels yet, before attempting the home run of the IPO. We’ve still got all those corporations, like Apple, Google and Microsoft (and many others) with vast amounts of cash on their balance sheet, courtesy of all the stimulus that quickly went to top of the food chain without creating any jobs or real investment along the way. So these were the last suckers who came in at the highest valuations often enriching the original founders who’ve long since retired to go surfing.
And finally here comes the IPO. Morgan and Goldman are expected to do their magic once again and unload this worthless and already withering stock in the IPO, still stuffing the pipe for the expected first day flip. There is a notion in finance if a bunch of people are having a meeting over dinner one of them is the mark, the sucker, and if you’re there and you don’t know who the mark is, well, it’s you. So these “professional” money managers, desperate to unload their cash, fell for the fast-talking Goldman/Morgan salesman and handed over the cash. They hadn’t gotten the memo that flipping on the first day was dead back in the 90s. So those ultimate suckers, the ones who’d paid off all the early investors already, got stuck with stock that the public didn’t want to buy, because amazingly the investment public read more of the analysis and could actually say the words, “business model”.
So, we have all the crashes now, as all pyramid schemes must do. When no more sucker money is available to pay off the old investors now these stocks actually can only have value if there is some way, honestly (given all the earlier financial statements were very creative accounting), for the business to make money. And as the now-audited quarterly reports come rolling in, guess what, what the insiders knew long ago, these companies don’t make any economic sense and will never make any money.
But the pyramid scheme isn’t quite depleted yet. We still have the bargain investors, the last of the gullible. They figure stock at half price is bound to go up. Well, not quite. What the few shorts that made money in the 2008 crash realized about all those trash toxic assets (who ever was gullible enough to believe a synthetic CDO could possibly have value?) is that worthless investments have two values: a) full face value until confidence is gone and everyone now knows they’re worthless, and, b) zero. There is no middle ground since the investments are worthless to begin with and once the scam is exposed these kinds of investments don’t just “adjust” a little and become a bargain at a lower price, there is no price where these investments make sense. The speculators that bought most of these recent IPO, as they slide to lower and lower share prices, are learning that one the hard way.
But it’s sad everything has gone bust before there was a chance for a boom. Not all of the startups are scams: some actually still do the old-fashioned inventing of new technology, some actually have real products people will pay a price higher than free to acquire, and some have a business model where their revenues might exceed their ad budget. But as usual we probably will throw the baby out with the bath water and all the startups will soon become toxic. So Twitter, you blew it, you waited too long, you thought you could build the pyramid up even higher before it would fall. And users of all these services, get ready to see nothing but ads on your walls and your personal data magically disappear (after first get sold to some junk marketer). Too bad, a real boom would have be nice.
So to all you suckers out there who bought Zygna or Groupon or Facebook, I hope you didn’t buy your Porsche on credit because there is a real encounter with a repo man in your future.