There are at least 73 venture-backed companies worth $1 billion or more, according to The Wall Street Journal. That is up significantly from prior years -- even at the height of the dot-com bubble, there were less than half as many billion-dollar start-ups.
Although these companies are currently private, many will eventually go public. At the same time, excessive private-market valuations affect publicly traded firms in several important ways and could be early evidence of a second tech bubble.
Far from speculative business models, many of these firms have attracted tens of millions of users and shaken up enormous industries: Xiaomi, despite being founded just five years ago, is already one of the largest handset vendors in the world. Uber has disrupted the transportation industry, seemingly forever. Pinterest and Snapchat have hundreds of millions of devoted users. Airbnb has encroached on the hotel industry enough to draw the ire of government regulators.
But even if these firms have transformative business models, they may not be sound enough to justify their lofty valuations. Xiaomi, for example, is worth about one-quarter of Samsung, despite its low profitability and unproven international success. Uber is worth about four times Hertz, and about two-thirds of General Motors. Pinterest is seeking an $11 billion valuation -- putting it on par with Michael Kors -- but has yet to generate meaningful revenue.
Several big-name investors have begun to sound the alarm bells, some going so far as to put money on the line. Most notably, hedge fund manager David Einhorn has bet against a large number of tech firms. Dubbed his "bubble basket," Einhorn is shorting Athenahealth and Amazon. The total number of short positions is unknown, but Einhorn believes each stock in the basket could fall as much as 90% if the tech bubble pops.
Why this time is different
Others are more skeptical. When I spoke to venture capitalist Peter Thiel last October, he was outright dismissive of the possibility of a second tech bubble. In contrast to the mania of the late 1990s, tech start-ups are now taking much longer to go public -- driving up their valuations and preventing the general public from participating (according to Thiel, a necessary component for a bubble).
Like Einhorn, Thiel has money on the line -- much of his net worth is tied up in private, multi-billion dollar start-ups (Palantir, SpaceX, Stripe, among others), and he sits on the board of Facebook, perhaps one of the firms most susceptible to a tech crash.
Much of Facebook's recent share price appreciation has been predicated on its ever-growing mobile advertising revenues. Some portion of these (though exactly how sizable is unknown -- Facebook will not comment) is flowing from venture-backed mobile companies seeking to popularize their own apps on the mobile platform.
In a recent blog post, venture capitalist Bill Gurley argues that the current situation is indeed unsustainable but not for reasons of valuation. Rather, Gurley believes the high valuation of these late-stage private companies is creating excessive risk. In order to justify their valuation, these companies are pursuing growth at all cost, burning through tremendous amounts of cash and in turn, putting their long-term survival in jeopardy.
Technology investors should care
Froth in the private markets has effects on publicly traded firms, both direct and indirect. Public tech companies have to compete with these private behemoths for talent and often in the market (Box and Dropbox, for example, versus Microsoft). They could be swayed into expensive acquisitions, wasting shareholder capital in the process.
Though you may not have the opportunity to invest directly in these firms yet, technology investors should watch these trends closely.
Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.