The Unicorns of Technology
James Mee examines whether the abundance of Unicorn companies is necessarily a precursor to a bear market
2015 saw the word “unicorn” become associated with young, generally unprofitable tech companies reaching billion-dollar valuations. Over the course of the year, 42 start-ups earned themselves the designation, and as we start 2016, it is likely that even more will become members of the “unicorn club”. Such valuations are suggestive of a build-up of risk in the tech space, reminiscent of 1999/2000. But should the current situation cause concern?
On the face of it, excessive valuations of any kind ought to steer the thoughtful investor into an apprehensive mood, particularly where we have already seen – in recent history – the disastrous consequences of following a laissez-faire investment policy. In the 2000 TMT bubble, for example, “eyeballs” and “clicks” were deemed better guides for valuation than actual profit or cash flow.
However, where this attitude pervaded the public markets in 1999/2000, it is today confined to the privately (that is, venture capital and management team) -owned companies. Indeed, as we transition into 2016, the broader (and larger) public market is nowhere near as concentrated in tech names as it was at the turn of the millennium. The chart below displays the weighting of the largest sector over time, with blue representing the Technology sector. What is clear is that while Technology is today the largest sector once again, it is by no means overwhelmingly so.
In addition to less concentration in the public market, recent write-downs in the private market are indicative of the caution with which investors view the space. Fidelity wrote some positions down by as much as 25% in Q4, perhaps highlighting the extent of the recent overvaluation, but certainly indicating that the Millennium Bubble is not yet out of the market’s (or regulator’s) memory.
While the proliferation of young, billion-dollar tech companies perhaps calls into question the analogy of the mythical unicorn, traditionally known for its rarity, we do not believe that they mark a warning signal for global risk assets en-masse, as they did at the turn of the millennium.
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