In our Valley, the so-called subprime mortgage crisis has been more a rumble in the distance than the wolves at the door. We don’t like the noise but local real-estate prices aren’t collapsing and, in any event, we’re in the high-tech business, you see. Entrepreneurs come to us for help in building the next Facebook, Google or Oracle (forgetting Larry Ellison, Oracle’s founder didn’t want VC money…). We don’t speculate in esoteric financial instruments, we don’t leverage, we don’t play derivative games. We do start-ups, a man and a dog growing into a company on the NASDAQ or an acquisition by Google.
2007 turned into a great Valley VC vintage: we invested $10.1bn last year, the highest in 6 years. Better said, the highest since the Bad Bubble days. (See the excellent PWC Money Tree. ) Inevitably, the Cassandras in our midst had to predict another fall. Look at these valuations: Facebook at more than $15bn, VMware’s market cap of more than $40bn, Apple and Google above $200 and $700 per share respectively, market caps approaching $200bn, more than 15 times those of Ford and General Motors (about $13bn each), more than Cisco’s ($150bn) and approaching Microsoft’s own $260bn. This was last November. Today, Apple, Google, VMware and other high fliers have shed about 40% of their value.
Is this The End — again? In a word, No. In two, Perhaps Worse.
No. We see none of the Internet Bubble follies. No smoke and mirror IPOs. No Enron, Qwest or MCI. No Henry Blodgets touting a stock outside and calling it a POS (Piece Of S–t) inside their Wall Street firms. And, above all, no Day Traders, no “widows and orphans”, no ordinary people yielding to the get rich quick temptation, to betting the tree would grow to the sky. For perspective, many Internet Bubble stock lost 90% of their value. Even Cisco, not exactly a vaporware company, fell from $90/sh to $8/sh in the space of 6 months. This is not what’s happening here — we think.
But, immune as we thought we were, the subprime crisis could be reaching us in ways we didn’t predict. As with the Internet Bubble, we’re dealing with normal humans falling for the unlimited growth mirage. But the numbers are much larger. Instead of trading high-tech high-concept stocks, tens of billions of dollars lost, the bets were made on the value of homes, trillions. Current estimates put the loans at risk above one trillion dollars with losses to exceed $500bn this year alone. This, you’ll say, impacts consumer spending, spending based on borrowing against one’s home value, the number that was supposed to climb forever. But how does it impact VC investments? Our funds have money to invest and, in contrast to previous years, we look more attractive than the Private Equity sector. We’re not leveraged (we don’t borrow money we can’t repay), we play a transparent game. Earlier this month, business writers started reporting concerns about the real value of cash. The real value of cash ? Today’s financial system works on a network of interlocking bets, sorry, contracts. See how a trader at Société Générale could buy contracts “worth” (E50bn) many times the total market value of his employer. Some of these bets are “safe”, tax-free municipal bonds come to mind. They are deemed “risk-free” because they are insured against the issuing municipality going bankrupt — it happens. But the data used for evaluating the risk, for calculating the insurance premium are obsolete. The sub-prime crisis has loaded the debt insurers to the breaking point and beyond.
Start-up companies with cash reserves need to park it somewhere safer than under a mattress. The rule is to invest the cash in “ultra-safe” instruments — muni bonds and other less well-known securities. You see where we’re going. We discover no one wants to convert these back into cash because the insurer behind the bond may or may not be solvent. I’ve seen e-mail exchanges where the bank that sold these so-called securities as a way to invest the “idle” cash reserve of a start-up now declares the cash no longer cash. And, of course, takes no responsibility for the advice, or the commission. Read the fine print. I’ll let you imagine how such e-mail propagate in our Valley. The sub-prime crisis finally managed to hit us where it hurts most — cash. — JLG