Archive for October 14th, 2014

The technology industry is clearly prospering, but has it entered a period of irrational exuberance? There are good reasons to worry that it has and that the bursting of this bubble could be painful, to investors in and employees of tech firms as well as to the broader economy.

By several measures — stock prices, multibillion-dollar acquisitions, the compensation of employees, the money being spent by start-ups that have little revenue or profits — the technology industry is in a period that is starting to feel like the late 1990s. Even some industry elders who lived through the previous boom and bust, including the venture capitalists Marc Andreessen and Bill Gurley, are warning that Silicon Valley might be overheating.

There are, of course, differences between the current boom and the earlier one. Most tech companies that have gone public in recent years, like Facebook and Twitter, are more mature than companies that created a frenzy on the stock market some 15 years ago before fizzling out, like Pets.com and Webvan. Tech companies that go public these days are more likely to be profitable or at least have been in business long enough to have some kind of track record.

Stock market valuations, measured by long-term corporate earnings, are high by historical standards but much lower than they were in early 2000, according to data collected by Robert Shiller, the Yale economist. That should provide some comfort to investors, though not much. At the end of trading on Friday, the tech-heavy Nasdaq composite index was down 7 percent from its recent high last month.

The problems are not limited to publicly traded companies. Many privately held tech companies have such easy access to venture capital that they are spending lavishly and burning through cash without a clear plan for turning a profit. Office rents in San Francisco jumped 10 percent in the first nine months of this year, according to the CBRE Group, which estimates that rents in that city could be higher than rents in Manhattan by the end of 2015. In a series of tweets, Mr. Andreessen recently said that many tech start-ups would probably fail and have to fire employees. He ended by telling his followers, “Worry.”

Much more of the current tech boom is concentrated in Silicon Valley than it was in the late 1990s. About half of the $22.7 billion that venture capital firms invested in start-ups in the first six months of this year went to businesses located there. By contrast, Silicon Valley’s share of venture capital investments was less than 35 percent during the late 1990s, according to a PricewaterhouseCoopers report. This suggests that a tech downturn could be particularly bad for the economy of Northern California.

It’s impossible to predict with precision when business cycles will turn. But as many investors learned more than a decade ago, the valuations of companies can outstrip their ability to make money for only so long.

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