Power

How the bear market could hit tech

Liquidity will be vital in the face of slowing sales — and expect to see ruthless prioritization.

Traders work on the floor of the New York Stock Exchange.

A raft of newer tech companies, like those built on the gig economy or video streaming, have never had to face up to a serious external financial shock.

Photo: Bloomberg via Getty Images

On the back of a disastrous week for the global economy, it could soon be time for some tech companies to fear for their futures.

This week, amid global fears about the impact of coronavirus, stock markets were pummeled. U.S. markets fell into bear territory, losing more than 20% of their value from a mid-February peak. A big rally in prices ahead of the closing bell Friday recouped sone of the losses, which might look like a bright spot. But major markets in the U.S. nevertheless remain in bear territory, and the gains and losses of the week serve to show that the only thing we can be sure of in the markets right now is uncertainty. One measure of market volatility, called Vix, reached levels not seen since the 2008 financial crisis.


Get what matters in tech, in your inbox every morning. Sign up for Source Code.


"People are more inclined to say it's a bump in the road and we're going to get over it," said Dr. Robert Cohen, a senior fellow at the Economic Strategy Institute. "But, in fact, I think since the tech world is so globalized and integrated that when these issues like the virus come up, the whole house of cards is under siege."

There is a very real chance that a recession is about to bite. John Normand, a head of strategy at JPMorgan Chase, said that the markets have now priced in an 80% probability of recession — the highest level it's ever been without the U.S. actually being in one.

What happens to tech if that becomes the case? Many of America's biggest technology companies didn't exist during the dot-com crash of two decades ago. Companies that weathered the 2008 crisis in sectors like digital advertising and ecommerce now bear little resemblance to the companies they were back then. And a raft of newer tech companies, like those built on the gig economy or video streaming, have never had to face up to a serious external financial shock.

"There really is no precedent," Moody's SVP Neil Begley told Protocol. He was talking specifically about the potential effect of a contraction on the digital advertising market, but the same can be said of tech as a whole.

How the sector emerges from a potentially severe economic downturn is an open question, but here's a look at what the near-future could look like.

Cash is king

Moody's sees one potential problem on the horizon: liquidity problems. If companies don't have enough cash to get them through a period of reduced revenue, they could default on their obligations and ultimately end up bankrupt.

For many tech companies, that's highly unlikely to be a problem. "I have no concerns whatsoever about Alphabet," Begley said, joking that it has so much cash that "they can actually be a lender to a lot of other companies." The same is true of companies such as Facebook and Apple.

Not everyone is so lucky. Netflix is a good example: It had a cash loss of $3.3 billion last year, and regularly issues bonds to raise capital to cover its spending. As is Box, which as of Jan. 31 had 20 times more debt than equity and an annual loss of $144 million. Begley said that for a company like Netflix, a yearlong financial disruption "could begin to be problematic, assuming they couldn't get additional financing from say, a bank." At least Netflix's reputation may provide it with options, though: It might be able to raise elsewhere, and it can always defer costs by delaying production.

The worst hit could be any companies where investors smell risk. "Less profitable firms or highly risky companies are at risk the most," Patrick Moorhead, president of Moor Insights & Strategy, told Protocol by email earlier this week. "Investors are looking to reduce risk and will exit those first." That could explain why companies such as Uber and Lyft have seen their stocks sink by more than the sector average this week and lost almost half their value in the last month.

Choose your markets

Concerns about cash-poor businesses were echoed by Cohen, who pointed to companies harnessing the labor force of the gig-economy as those with perhaps the most exposure. His lesson from the dot-com bubble: Don't underestimate how quickly those financial problems could come home to roost.

During the bull market of the last decade, investors have often turned a blind eye to the iffy balance sheets of companies hoping to prove out the viability of new business models through growth rather than profit. That is a benefit rarely afforded when credit markets dry up.

But months down the road, Cohen doesn't see the economic damage inflicted by coronavirus being limited to the demise of some new kids on the block. Rather than seeing the giants going belly up, he expects established companies to restructure and pull out of markets where other power players are already dominating.

He says that could further manifest itself in a cutback of the kinds of programs companies use to reskill workers to make themselves more nimble in those emerging markets. If that does become the case, a period of decreased competition and a lack of innovation could sweep a sector that's built its reputation and valuation on exactly the opposite principles.

Withering sales

With much of the economy on the brink of slowing to a near standstill, demand is likely to steadily worsen as stores shutter, commerce slows and whole cities go into lockdown. And even product demand that might otherwise be unaffected by the viral tumult still stands to wither. That's a likely effect of canceling scores of tech events around the country in the coming months, according to technology analyst Rob Enderle.

Many tech companies depend on annual spring and early summer meetings, such as Dell Technologies World and IBM's Think 2020 conferences, to lock in sales for the coming year, Enderle said.

"Even when the supply pipeline out of China gets back up and running, as appears to be happening, companies will struggle to fill the sales pipeline because the events that did that are no longer in existence," Enderle said. "If you're in hardware right now or software or services, you have the same problem with regards to sales, because your mechanism for building demand has just got blown up."

Enderle says many companies are ill-prepared to gin up sales in virtual events the same way they do through physical, in-person events. "There have been attempts in the past to take these things virtual, and they've all failed," he said.

Disrupters not disrupted

Downturns tend to bring a slowdown to the advertising world, and this time would be no different. Moody's predicts that there would be "a short-term negative effect on U.S. advertising, stemming from a swift and deep economic pullback." But digital players — particularly Alphabet and Facebook — could come out of that better than traditional media firms.

"Because of the highly targeted nature of digital advertising, it tends to be more efficient, and therefore the return is much stronger," Moody's Begley said. "So you can imagine that if somebody is going to pull back in spending, they're going to pull back on some of the broad and expensive branding spending that they might do on television or other expensive mediums." He added: "The last thing they're gonna pull back on is more-targeted advertising."

Facebook, Alphabet, and perhaps even Twitter then, may be OK. Begley said he thinks digital players will experience slower revenue growth, compared to a revenue contraction for traditional media firms. But it's important to note that Moody's thinks any disruption to advertising will be short term.

Time to buy?

On Friday, SoftBank announced it would buy back $4.8 billion worth of its stock — that's up to 7% of all its shares. That decision came partly because of pressure from activist investor Elliott Management that preceded the crash, yes, but this week's downturn clearly played a part.

SoftBank's shares have lost a quarter of their value so far this month. In SoftBank's eyes, that means its shares are undervalued, making it a perfect opportunity to buy them back. That has two effects: It will drive up SoftBank's share price, providing a return to shareholders, and it reduces the amount that SoftBank will need to pay out in future dividends.

SoftBank is not alone in seeing its shares crash this month, and it might not be alone in buying those shares back, either. Rachel Ziemba, an economist at the Center for a New American Security, told Protocol that many of the biggest tech companies might follow this strategy. "They tend to have significant cash reserves and thus might look for an opportunity for more buybacks and consolidation," she said.

Uncertainty for startups

Venture capitalists are already warning that the funding environment could be changing. In its now famous Black Swan memo, Sequoia warned its portfolio companies to prepare for a downturn, which might mean that private funding could "soften significantly, as happened in 2001 and 2009."

"I think we've been in a boom market, and most of the contingency plans have been to figure out what to do on the upside: If we raise more money, what would we do? If we exceed our revenue targets, what else should we invest in?" Sequoia partner Alfred Lin told Protocol last week. "Here it's a reminder that you should have contingency plans for the upside and the downside and we wanted people to make sure they have the downside scenarios in place."

Related:

It doesn't necessarily mean that venture funding will be down across the board near-term. In fact, many venture capitalists are saying that deals are still getting done and the industry remains open for business. Haystack GP and Lightspeed venture partner Semil Shah told Protocol that he thinks it's going to vary by investing stage. Angel investors, for example, may be getting hammered in the public market and may be more cautious in investing. Syndicate groups, which pool together other investors' money, may also see a slowdown thanks to the market troubles and the hassle of pulling everyone together.

More traditional venture funds and growth-stage funds are also now adapting to a remote-work culture and trying to find new ways to replicate the partner meetings and due diligence process. "That coordination cost is going to slow down some of the new deal-making," Shah said. Plus, a lot of investors are also splitting their focus to pay attention to their current portfolio companies and helping them to plan and prepare.

One area he thinks won't slow down is seed investing, which has seen an explosion of funds that could have a lot of dry powder sitting around. Still, investment levels — and deal terms — might not be where they were before the coronavirus outbreak and subsequent market meltdown.

"Founders may think prices are going down, but I think they're normalizing because they've been out of control," Shah said. "We've had three to four years of people without a line of code written raising $4 [million] or $5 million."

A win for China?

As the U.S. wrestles with the impact of coronavirus on the economy, an unlikely player is poised for a big win: It increasingly looks like China will recover from coronavirus just as the U.S. and Europe are hit hardest by it. The U.S. and Europe are unlikely to take the same sort of aggressive measures to contain the illness as China did, meaning its effects could hit harder and drag on longer.

"Because China has been able to mitigate this as rapidly as they did, they may be the biggest beneficiary," Enderle said. "That's going to put them in a very favorable position to be able to take the market. We're going to see an awful lot of business shifting to China."

But not so fast, says Van Hesser, the chief credit strategist for the Kroll Bond Rating Agency. Hesser says the significant supply chain disruptions tech has endured because of the virus may convince tech companies to diversify their lines of supply.

"You're going to see people, manufacturers rethink how vulnerable they are to one particular part of the world," Hesser said. "You'll see a rethink of that dependence on China, that maybe it's not such a good idea to put all your eggs in one basket."

Theranos’ investor pitches go on trial

Prosecutors in the Elizabeth Holmes fraud case are now highlighting allegations the company sought to mislead investors.

The fresh details of unproven claims made about the viability of Theranos' blood tests and efforts to conceal errors when demonstrating testing equipment added to the evidence against Holmes, who is accused of fraud in her role leading the company.

Photo: David Paul Morris/Bloomberg via Getty Images

The Theranos trial continued this week with testimony from Daniel Edlin, a former product manager at the blood-testing startup, and Shane Weber, a scientist from Pfizer. Their testimonies appeared to bolster the government's argument that Holmes intentionally defrauded investors and patients.

The fresh details about audacious and unproven claims made about the viability of Theranos' blood tests and efforts to conceal errors when demonstrating testing equipment added to the evidence against Holmes, who is accused of fraud in her role leading the company.

Keep Reading Show less
Aisha Counts

Aisha Counts (@aishacounts) is a reporting fellow at Protocol, based out of Los Angeles. Previously, she worked for Ernst & Young, where she researched and wrote about the future of work, emerging technologies and startups. She is a graduate of the University of Southern California, where she studied business and philosophy. She can be reached at acounts@protocol.com.

The way we work has fundamentally changed. COVID-19 upended business dealings and office work processes, putting into hyperdrive a move towards digital collaboration platforms that allow teams to streamline processes and communicate from anywhere. According to the International Data Corporation, the revenue for worldwide collaboration applications increased 32.9 percent from 2019 to 2020, reaching $22.6 billion; it's expected to become a $50.7 billion industry by 2025.

"While consumers and early adopter businesses had widely embraced collaborative applications prior to the pandemic, the market saw five years' worth of new users in the first six months of 2020," said Wayne Kurtzman, research director of social and collaboration at IDC. "This has cemented collaboration, at least to some extent, for every business, large and small."

Keep Reading Show less
Kate Silver

Kate Silver is an award-winning reporter and editor with 15-plus years of journalism experience. Based in Chicago, she specializes in feature and business reporting. Kate's reporting has appeared in the Washington Post, The Chicago Tribune, The Atlantic's CityLab, Atlas Obscura, The Telegraph and many other outlets.

Protocol | Policy

8 takeaways from states’ new filing against Google

New details have been unsealed in the states' antitrust suit against Google for anticompetitive behavior in the ads market.

Google is facing complaints by government competition enforcers on several fronts.

Photo: Drew Angerer/Getty Images

Up to 22%: That's the fee Google charges publishers for sales on its online ad exchanges, according to newly unredacted details in a complaint by several state attorneys general.

The figure is just one of the many details that a court allowed the states to unveil Friday. Many had more or less remained secrets inside Google and the online publishing industry, even through prior legal complaints and eager public interest.

Keep Reading Show less
Ben Brody

Ben Brody (@ BenBrodyDC) is a senior reporter at Protocol focusing on how Congress, courts and agencies affect the online world we live in. He formerly covered tech policy and lobbying (including antitrust, Section 230 and privacy) at Bloomberg News, where he previously reported on the influence industry, government ethics and the 2016 presidential election. Before that, Ben covered business news at CNNMoney and AdAge, and all manner of stories in and around New York. He still loves appearing on the New York news radio he grew up with.

Protocol | Workplace

This tech founder uses a converted Sprinter van as an office on wheels

The CEO of productivity startup Rock likes to work on the road. Here's how he does it — starting with three different WiFi hotspots.

Kenzo Fong, founder and CEO of the 20-person productivity software startup Rock, has been working out of his converted Mercedes-Benz Sprinter van since the pandemic began.

Photo: Kenzo Fong/Rock

Plenty of techies have started companies in garages. Try running a startup from a van.

In San Francisco, one software company founder has been using a converted Mercedes-Benz Sprinter van — picture an Amazon delivery vehicle — as a mobile office.

Keep Reading Show less
Allison Levitsky
Allison Levitsky is a reporter at Protocol covering workplace issues in tech. She previously covered big tech companies and the tech workforce for the Silicon Valley Business Journal. Allison grew up in the Bay Area and graduated from UC Berkeley.
Protocol | Policy

Most Americans want AI regulation — and they want it yesterday

In a poll, people said they wanted to see artificial intelligence technologies develop in the U.S. — alongside rules governing their use.

U.S. lawmakers have only just begun the long process of regulating the use of AI.

Photo: Louis Velazquez/Unsplash

Nearly two-thirds of Americans want the U.S to regulate the development and use of artificial intelligence in the next year or sooner — with half saying that regulation should have begun yesterday, according to a Morning Consult poll. Another 13% say that regulation should start in the next year.

"You can thread this together," Austin Carson, founder of new nonprofit group SeedAI and former government relations lead for Nvidia, said in an email. "Half or more Americans want to address all of these things, split pretty evenly along ideological lines."

Keep Reading Show less
Ben Brody

Ben Brody (@ BenBrodyDC) is a senior reporter at Protocol focusing on how Congress, courts and agencies affect the online world we live in. He formerly covered tech policy and lobbying (including antitrust, Section 230 and privacy) at Bloomberg News, where he previously reported on the influence industry, government ethics and the 2016 presidential election. Before that, Ben covered business news at CNNMoney and AdAge, and all manner of stories in and around New York. He still loves appearing on the New York news radio he grew up with.

ai
Latest Stories