Wolf Richter: Cracks In The Tech Bubble (That Doesn’t Exist)

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Testosterone Pit.

“You get the scale, you get the feeling of the actual home,” said Randy Churchill, a Bay Area real estate broker. He was explaining why realtors were using drones to shoot aerial videos of high-end properties. He’d hired a company for $500 to produce the whole schmear. A lot cheaper than using a helicopter and crew. These videos are expected to bounce around the social media and land, hopefully, in front of potential buyers.

And it’s illegal. The FAA prohibits commercial use of drones, but their commercial use is ballooning. It’s “a technology everyone is going to have,” he said – and no one is going to be able to stop it, he implied.

Life in the Bay Area. It comes in waves of money that wash over the area and slosh around for a few years, only to recede again and leave many high and dry. These are San Francisco’s and Silicon Valley’s storied booms, bubbles, and – always – busts. Everyone loves the boom and the subsequent bubble that gets bigger and bigger as more and more money sloshes around with practically nowhere to go [well, not everyone loves them, read… Housing Bubble 2.0 Hits Messy Resistance In California].

Then the inevitable happens. After having denied feverishly that any kind of bubble exists, people watch incredulously as the hot air hisses out of the very bubble whose existence they’re still denying. And afterwards, everyone had seen it coming. Because cracks had been visible for a long time.

One of the cracks is Twitter. The company went public in November at $26 a share and soared to $74.73 by late December, giving it a market value of about $40 billion at the time. It reported “earnings” yesterday for the quarter during which it had gone public. Its hype machine in overdrive, you’d think it actually made money, with headlines like, “Twitter Finally Turns A Profit…“ or “Twitter Ends 2013 With A Surprise Profit.” And yet, in the quarter alone, Twitter lost over half a billion US bucks.

So Twitter has some, let’s say, issues. The number of users grew by only 3.8% to 241 million, the fourth quarter in a row of slowing growth. Not a lot of users to begin with, when you think about the price tag of the company. And then there’s the fiasco of “timeline use,” one of Twitter’s own handy-dandy metrics that gets triggered every time a user refreshes the timeline page. It skidded from the prior quarter. So they’re going to redo things and tweak stuff, as CEO Dick Costolo explained during the earnings call, “to change the slope of the growth curve.”

Even the SEC, which hardly ever warns about the tricks of Wall Street, warned about these homemade metrics the day before Twitter’s IPO, though it assiduously avoided naming Twitter. SEC Chair Mary Jo White pointed out that “the link from metric to income and eventual profitability may not be clear or even identified.” Now that link is murkier than ever before.

Twitter raked in a net loss of $511.5 million on $242.7 million in revenues, based on Generally Accepted Accounting Principles, the infamous GAAP, the rules by which US corporations must present their results to investors. More than double the revenues from a year ago, more than 58 times the losses. Way to go.

But then Twitter applied its own set of rules, and instead of a mega-loss, came up with a “non-GAAP” profit of $9.8 million. Halleluiah. One of the items excluded from this well-crafted profit? $521 million of stock-based employee compensation expense. Part of this money is now audibly sloshing around San Francisco and driving up prices.

Unlike money-is-no-objective Twitter and startups with multi-billion dollar valuations, no profits, and minuscule revenues, San Francisco companies like Charles Schwab have to be profitable. They’re watching their costs – and costs are rising as the sloshing money drives up prices for everything in San Francisco. And now Charles Schwab is reacting. It told employees that over the next few years it would move a “significant number” of jobs from its headquarters – apparently over 1,000 – to other states, possibly Colorado and Texas.

Which induced Texas Gov. Rick Perry to gloat, ironically on San Francisco’s Twitter, “Looks like more California jobs coming to Texas.”

Schwab’s move would vacate about 225,000 square feet of office space in the Financial District, of the 744,000 square feet it currently occupies, the San Francisco Business Times reported. “Financial District” is increasingly a misnomer: jobs in financial services have plunged from 34,800 in 2007 to 26,600 by Q3 2013. Tech is moving in. Now that it’s awash in investor money, no one is looking at expenses.

The 375,000 square feet that Schwab used to occupy in the One Montgomery Tower before it pulled up some stakes the last time is largely occupied by LinkedIn. Startups Uber and Square – valued at $3.8 billion and 3.3 billion respectively – are spread out in Bank of America’s former office space on 1455 Market Street. Eventbrite is in Wells Fargo’s ex-digs at 155 Fifth Street. Gaming startup Supercell, which has a $3 billion valuation, is setting up shop where Banker’s Club used to be on the top floor of the Bank of America building.

Last time, when cracks appeared in the tech bubble, it didn’t take long for the sloshing money to evaporate. It didn’t go anywhere else. It just disappeared. The only trace of untold billions of dollars in investor money was the detritus left behind. And that was it – until a new wave of money washed over it.

Outside the startup bubble, tech isn’t exactly booming, as we’ve seen from numerous revenue and earnings debacles, collapsing sales by US tech companies in China and Russia, massive layoffs…. But that hasn’t kept “valuations” of money-losing tech startups from being pushed into the stratosphere – for the benefit of a very elite club. Read…. How to Manipulate the Entire IPO Market With Just $250 Million

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  1. Clive

    I’ve started using a proxy for the desperation of Tech Bubble 2.0 companies based on the level of intrusiveness that their either blatant ad pushing or (as the companies concerned are probably hoping) more “subtle” attempts at increasing user engagement/utilisation levels. The latest iOS version of Twitter (6.1) has crossed that threshold for me with it’s non-optout’able “suggestions”. No, just because I’m following some friends who regularly tweet pictures to @CutesyCatsoftheDay it doesn’t mean I’m going to view those tweets. There’s a limit to the amount of times I’m willing to tell Twitter “not interested, show me less of this”. Facebook receded over that particular event horizon a good year or so ago rendering it unusable. Don’t even get me started on LinkedIn. Twitter is going the same way.

    Making serious, sustainable money from e-commerce is tough going. Those valuations look decidedly toppy. If it’s just hot money propping them up, collapses can happen real quick.

    1. Walter Map

      I’m persuaded that it really is hot money that’s propping them up.

      Capital formation has become excessive and is way too far ahead of other economic factors, creating a topheavy, hugely unbalanced system. The obscenely wealthy have oceans more money than they can spend, and if they leave it in cash they lose money to inflation. Same with ordinary savings instruments. They want to maximize their returns, but the hollowed-out real economy can’t really support good returns on conventional investments. To get the highest returns they put it into junk bonds, which have gone through the roof, or it into something sexy, and tech is sexy.

      Bubbles are easy to make when you have too much investment money chasing sexy investments with lousy returns. Throwing good money after bad, like the Fed is doing with overdone QE, only makes it worse. Contemporary capitalism doesn’t exactly rest on a solid economic foundation because the consumer base that supports it is getting gutted.

      Despite the whining you read on NC about the more fanciful aspects of contemporary economics, the basic principles nevertheless have considerable validity, and those basic principles assure us that a whopping crash and burn is inevitable.

  2. ambrit

    “$521 million in stock based employee compensation expense,” out of “242.7 million in revenues” equals fraud in any clear sighted individuals book. Why aren’t the stockholders bringing suit? “Calling Richard Smith! Con men on the loose!”

    1. diptherio

      Yeah, when compensation for employees is more than double revenues, something is obviously up. And though I’m not super hip to the lingo, it sounds to me like that $521 mil. is just a part of total employee compensation.

      Of course, everybody is free to look at the GAAP report that shows them bleeding money, so the moral here may simply be caveat emptor.

    2. Danny

      This is to be expected with any IPO for a company has been around a few years and the company -like most tech companies- gives a lot of stock options. A lot of early employees were probably sitting on vested options just waiting for the day they could exercise on the open market. The thing about stock options that is different than bonuses is that you need to put in a certain amount of time at the company before they vest and are legally worth anything.

      1. DS

        @Danny, it depends on the terms of your grants, but in general if there is a liquidity event (e.g. acquisition or IPO), the options vest in full on the effective date.

        However, there are also typically lockup periods after the liquidity event that prevent rank and file employees from selling their shares. Senior management is sometimes exempt from these and other sale-related restrictions.

        Meanwhile, the VCs, underwriters, or typically anyone who owns preferred shares, can often dump their stock the day of the iPO or whenever they want.

        It is very, very rare for employees to earn a return on their options. The founders and management team have a better shot, but even then, it’s the investors and money guys who always stand to win the most.

  3. TarheelDem

    There is no better reason than the idea of real estate agents and developers filling the sky with drones for local governments to pass anti-drone ordinances.

    The fact that this entrepreneur is willing to break this one federal law makes one wonder what other laws they are willing to break.

    Are we coming to a point of having to define private airspace in ways similar to the way we define ownership of waterways or beachfronts. Rule for private ownership. Rule for state ownership. Rule for national ownership. International waters or airspace. (For airspace, this line marks the boundary between national airspace and “outer space” within national territory boundaries.)

  4. peter de haan

    Tech bubbles have sustained me, my family and many of my friends for over 15 years now. Companies I’ve worked for typically don’t generate profits – only the perceived expectations thereof. I’ve never struck it rich, mind you, as stock options hardly ever pan out for worker bees like myself in this highly volatile environment. The one perk I like is that they usually ship my butt to the bay area once a year ; expenses paid ; all the way from Brazil where I am based, to participate in some ‘global sales rally’ (glorified internal PR stunt to motivate the troops after yet another disappointing year).

  5. sd

    Football games have been flying remote control (drone) cameras over games for at least a decade if not two. How is shooting photos of houses any different?

      1. sd

        Enlighten me. The only possible issue for filming over private property would be if the property owner does not grant permission, however, the article makes clear filming is for the purpose of selling a property, and one would assume, at the owners demand.

  6. curlydan

    Uber is about to get regulated as a transportation company. There’s just too much money and power at stake for localities not to regulate them.

  7. Waking Up

    There also is the issue of privacy rights which many of these large tech companies in the United States seem to feel they can ignore. They may feel large and flush with money now (or maybe the distribution of money reflects desperation and a desire to make sure the executives have been well compensated and can easily walk away), but being that these companies usage depends upon trends, they better remember what happens when the users want to visit the “newest nightclub” or use a search engine that doesn’t compile data for the NSA.

  8. lee

    The twtteratti and their ilk have been providing a lot of employment of late for friends of mine who specialize in remodeling and updating fine old buildings in the bay area. I will pass on the bad news.

    I find these social media at best trivial at worst creepy and the mass facination with them incomprehensible but around here it’s becoming ever more difficult to make a decent living working for people who provide meaningful life enhancing goods and services.

  9. Tommy

    To see the importance of this site, and people like Whitney, Richter, Yves, etc…
    after reading this post, go to socket in SF; a real estate site where 99% of the commenters
    harangue anyone telling them this a bubble that will pop. The bastards again have kicked out thousands of my neighbors of 20 years or more, for their greed. This pop, that leads to a depression, may finally put enough working class people in the bay area over the edge, to put fear back in these arrogant leaches.
    I have nothing else to look forward to.

  10. Ep3

    Yves, I want to bring up a jobs stat i heard about recently. Here in Lansing Michigan, just like flint, the economy revolved around the automobile. In 1979, GM employed 29,000 persons at its main plant, near downtown Lansing. In the heart of what is now considered the Lansing ghetto. The main plant does not count the body plant, the soon to be built engine plant, the “craft centre”, and plant 3, with smaller but significant work forces. The other day the capitol paper stated GM employs 4,000 workers TOTAL at the two plants it operates in “Lansing”. I quote Lansing because one plant, instead of building on the vast empty acres of parking lot GM “owns” all over Lansing, they chose to tear up a piece of farm land several miles outside the city. Where did those jobs go? Why are our cities falling apart? What are ppl going to do in the future? These are questions not mentioned in the local paper, by the local mayor.

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