Silicon Valley Is Headed for Disaster, and No One Can Save It

Faris Algosaibi / Flickr
Faris Algosaibi / Flickr

San Francisco, heartland of wacky progressive politics but also home to some of America’s most innovative technology companies, is in trouble. Not just trouble, actually, but serious shit.

And the main reason is China. The Wall Street Journal has a good explainer on what’s going on over there, but the basic thing you need to understand is that a lot of glossy American stocks are about to take a tumble, especially tech stocks.

Chinese businessmen, drama queens that they are, have started throwing themselves off Beijing skyscrapers. That makes for good headlines, but it’s also a warning sign to American entrepreneurs and investors thanks to the influence on global markets that China is already having.

(Don’t feel too bad for these suicidal fat cats, by the way: their falls are being cushioned by the bodies of Foxconn factory workers assembling iPhones.)

Talking heads on CNBC are gearing up to sound smart about a crisis they should have seen coming months ago. But if you want a quick economic primer on what’s about to happen to America’s young tech giants, here it is.

Expensive stocks take the hit first when things go wrong in the wider economy. Technology companies are getting blasted because, frankly, there is fat on the bone. But there are two other factors in play: first, all tech companies are to some degree punts or speculation.

No one needs a new formula for mac and cheese every year, but innovation requires punts on better ways of doing things in the future that may or may not pan out. Set aside consulting, data storage, and a few business-to-business services, and technology as a category looks hugely vulnerable.

That’s not only because tech investors are making risky bets but because America’s technology darlings aren’t exactly making good on Silicon Valley’s legacy. Microsoft, Cisco, IBM and a few other businesses of the old guard have a reasonable claim to being the companies that run the world, but Twitter and Facebook? Not so much – whatever their crazy valuations.

You see, as much as global financial concerns are going to hit tech companies harder than other sorts of enterprise, so too will their own lack of ambition. The ugly truth is that Silicon Valley has largely given up trying to fix big problems and has retreated into photo-sharing apps and productivity tools. That may sound harsh, but just look at some of the absurd and pointless startups that are getting vast checks written and tell me that founders don’t need a kick up the ass and a reminder that no one has solved batteries yet.

The problem for companies who build social software is that no one is going to bail them out when investors lose patience. That’s because they’re not building anything of lasting value to anyone. These “glamour stocks” need to go through a painful reappraisal before they can be considered serious long-term investments. The greatest engineering minds of our generation aren’t building hovercars or jetpacks or invisibility cloaks but working out how to make people click on ads.

And social software is a winner-takes-all business. If Facebook doesn’t stay number one, it’s essentially worthless.

Fear and greed run the stock market, which is, of course, exactly as it should be: they’re the instincts upon which capitalism is built. But that’s a problem for companies who suffer dramatically when global events conspire to shunt investors into safer bets.

Businesses like Twitter and Facebook have always been grotesquely overvalued, according to conventional analyses. Technology companies get away with hilarious valuations mainly thanks to upward pressure; the inflation happens right at the start when companies raise hundreds of millions of dollars on multimillion dollar valuations, despite not earning a penny in revenue and having no immediate plans to do so.

That’s in outrageous contradiction to their price-to-earnings ratio, one traditional and very reliable way of valuing companies.

Tech stocks have absurdly high price-to-earnings ratios, and any blip in the market has a much bigger effect on high PE stocks than low PE stocks. So investors are counting on massive future growth that will likely never come and betting against global events that shave billions off the value of frothy investments.

Look at Tesla. The forward PE ratio is very high: it’s a very expensive stock. Tesla is counting on the future being lush and green. But if, for whatever reason, the future suddenly stops looking so verdant, Elon Musk’s company is in serious trouble. And let’s remember, Tesla can only function thanks to ten-digit subsidies.

(Tesla may be dependent on billion-dollar subsidies, but the company is at least solving a problem: what happens when fossil fuels get inconveniently expensive. Sure, electric cars are hideously ugly and totally sinister – have you ever had a Toyota Prius creep up on you? – but everyone gets the urgency of the project, hence the government backing.)

Twitter, the ultimate glamour stock, can’t even be analysed by PE ratio because it doesn’t make any money and hasn’t ever done so. Part of the reason is its obsessive and bizarre focus on politics and policing its platform for “unacceptable” (read: conservative) speech, which is screwing its chances of being the world’s conversation medium.

America will always plant crops and need chemicals to service those crops. And it will always need payment, delivery and data services. But will it always need Facebook and Twitter? Cisco runs a large proportion of the Internet; Facebook hosts your grandma’s pictures. You do the math.

There won’t be any suicides in Silicon Valley – the most dangerous thing to happen in northern California occurred last month when an angel investor’s Birkenstocks got caught in the BART elevator – but the whole edifice on which the delicate San Francisco ecosystem is based is about to come crashing down all over again.

The only silver lining in all this is that Jim Cramer is about lose what little remaining hair he had as all of his recent “buy” picks melt into oblivion. You heard it here first.

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