Pando

Are we now in a bear tech market?

By Kevin Kelleher , written on July 7, 2017

From The Economics Desk

Silicon Valley is having something of a Dickensian moment, where it seems at once the best of times and the worst of times.

On the one hand, tech has been outperforming most other industries for much of the past year. The S&P's information technology sector has risen 29% in the past year, or roughly double the S&P 500's overall performance, even though the tech sector is down 5% in the past month. 

On the other hand, take a look at recent tech headlines and it quickly starts to read like what you'd see in a recession. Jawbone is shutting down, having begun liquidation proceedings on June 19, according to The Information. Business Insider reported the company has been having problems paying vendors and managing inventory. Once valued at $3 billion, Jawbone raised $950 million as it pivoted from bluetooth headsets to wireless speakers, and pivoted again to fitness trackers. Many Jawbone employees have moved to a new healthcare startup also founded by Hosain Rahman. Some Jawbone creditors will reportedly receive a stake in the new company. Equity holders appear to be out of luck.

Soundcloud, meanwhile, is laying off 173 of its 420 workers in a push to improve its financials as it competes against Spotify, Apple Music and others, according to Bloomberg. Despite having around 175 million listeners, Soundcloud's tracks are mostly free songs from up-and-coming artists or podcasts hosted on the site, a challenge to the company's efforts to build a strong business model. The company has previously explored a sale to Twitter and Spotify, although it now says the cuts are being made to keep the company independent.

Microsoft, meanwhile, is cutting as many as 4,000 jobs, mostly from overseas sales and marketing teams. The move isn't necessarily a red flag for Microsoft, but rather a reorganization of its sales operations as it moves away from on-premise applications to Azure and other cloud businesses. The layoffs add to the nearly 28,000 that Microsoft has announced since 2014.

And that's just the bad tech news from the last 24 hours.

Not long ago, we saw Pandora lose its CEO and president as minority owner Liberty Media plots its plans to fold the music-streaming company into SiriusXM. In May, Tidal also lost its CEO, the third CEO to depart the role in a little more than two years. Tesla's stock is down 20% in the past two weeks, driven by concerns this week that some model sales have plateaued. Fitbit's new smartwatch is hitting some snags as the popularity of its fitness trackers declines. Other hardware companies like GoPro, Lytro and Pebble have faced their own tribulations in recent months.

Each of these companies has its own reason for its troubles and/or declining valuation. So it's important to avoid the temptation of generalizing them into a simple, overarching explanation. At the same time, there is a clear trend emerging of bullish tolerance giving way to bearish consternation. That trend seems to have gained momentum in the past week or so.

And then there is the fabulous FAAMG, this summer's annoying acronym for rallying tech giants. While the share prices of all five are down between 3% and 7% in the past month, they are still up between 30% and 50% for the past year.

This isn't to say tech is suffering in July 2017. Again, the FAAMG are having a strong year despite their declines in the past month. Other technology issues are having a good year too. Workday is up 45% year to date, while Adobe is up 37% and PayPal is up 35%. These are companies positioned as leaders in growing markets such as the cloud or mobile commerce. The companies struggling are the smaller ones competing against the formidable FAAMG. SoundCloud is up against rival services from Apple, Amazon and Google. Jawbone's fitness trackers compete not just against Apple Watch, but also the Apple ecosystem it belongs into.

In July 2017, Silicon Valley resembles a small town where two very different communities live on separate sides of the tracks. There are the FAAMGs, residing in their opulent mansions on the hill, and there are the other companies that are struggling to make ends meet, sometimes wondering how they'll get through the year.

The changes at Microsoft illustrate the bifurcated fates of tech companies in general. Microsoft can afford to throw money into Bing and shrug off declining sales of Windows OS and Office's packaged software because its early move into the cloud made it a leader in that market, with Azure and Office 365. And being a leader in the enterprise cloud is as sweet as sweet spots get in the tech industry right now. The deteriorating businesses are still bringing in plenty of revenue, but the company is focusing its resources on new growth.

And here we have tech in a nutshell. The old-fashioned notion of tech as a growth industry – where growing revenue leads to a) growing profit, b) growing market share, or c) both – is still alive and well. It's just limited to the sunny side of the railroad tracks. Meanwhile, a lot of tech companies are bringing in plenty of revenue, but either that revenue isn't growing very quickly - if it's growing at all - or companies are having trouble distilling that revenue into profitability.

In the past year or so, investors public and private have quietly shifted their attention from rapid revenue growth to profitability. That has left many cash-burning startups short of opportunities to raise the capital they need to bridge them to a profitable future – if and when that future arrives. As we noted this week, many tech companies braving the IPO market are doing so while burning down their cash piles. Last week, two IPOs, Blue Apron and Tintri, did push through to the public stock market, only at discounts to their hoped-for offering prices.

For every star like Amazon or Facebook in the public market, there are quite a few underachievers. Fitbit is down 29% so far in 2017, while GoPro is down 8%, TripAdvisor is down 23%, and Yelp is down 21%. Snap is 31 cents above its $17 a share offering price, and also 29% below where it closed on its first day of trading. Declines of 20% or more are considered to be signs of a bear market.

As for tech companies that went public in 2016, many of them have become some of the sector's worst performers in 2017. Nutanix is down 30% this year. Acacia Communications is down 35%. NantHealth is down 62%.

In coming weeks, there may be more mayhem among weaker tech companies once the second-quarter earnings season begins. Already this year, Snap, Yelp, Fitbit, and Tripadvisor all saw their share prices gap down after posting earnings reports that failed to meet investors demands. Given the skeptical eye Wall Street has been casting over the tech sector during the last month, any company hinting at weakness, or otherwise not living up to expectations, could be punished.

Of course, the tech giants that exceed expectations will keep on rallying. But at some point tech investors will need to ask themselves: Are we still in a bull tech market or have we entered a bear tech market? When enough of the non-giants see their publicly traded shares plummet, or their private valuations take haircut after haircut, or are pressured to lay off workers, or are forced to shut down – do the rallies of a handful of big companies constitute growth? Or do we need to talk about tech growth with an asterisk next to it?