The view from Silicon Valley
While Wall Street writhes in agony, how are things in the land of tech? Well, maybe not business as usual. But there are certainly worse places to be.
(Fortune Magazine) -- The heads-down, can-do entrepreneurs, and libertarian-minded financiers who populate the tech industry aren't typically the sorts to long for a government handout. But in the wake of the Treasury Department's $700-billion-plus rescue plan, Peter Thiel speaks for many when he asks a simple question: "What happened to the dot-com bailout?"
Thiel's not serious - at least not entirely. As founder of hedge fund Clarium Capital and VC firm Founders Fund - with early investments in Facebook, Slide, and LinkedIn, among others - he doesn't need anyone's charity. But as far as bailouts go, his point is that rescuing the Valley would have at least sent a positive message. Even the most vapid online pet-food delivery business looks benign next to arcane financial instruments designed to line the pockets of investment bankers. "It is an odd reflection on the priorities of our society," Thiel says, "that we value finance over technological innovation."
Welcome to Silicon Valley, where locals view Washington with distrust (except when lobbying for more H-1B visas), and the unifying attitude can be summarized in five words: You get what you deserve. Failure is considered as integral to creation as success here, and it's expected that both be allowed to take their natural course. But the collapse of Wall Street is clearly more than an ideological matter. For all of the talk in the Valley about wanting to be left alone, the financial crisis makes it clear that the Valley isn't an island. After all, a fifth of all IT spending comes from the financial sector.
On the positive side, with a few exceptions, the biggest players in tech do a lot of international business, providing a cushion during a domestic downturn. They also don't borrow much money and so aren't as exposed to credit crunch. In fact, many of the Valley blue chips are cash machines. Take Intel (INTC, Fortune 500); it has $12 billion in the bank and just $2 billion in debt. Chairman Craig Barrett said in late September that he had no plans to curb capital spending or R&D. The biggest problem for Microsoft (MSFT, Fortune 500) (it's not in the Valley, but it's clearly of the Valley) has been figuring out where to spend all its cash. The company recently announced a $40 billion stock-buyback plan. HP (HPQ, Fortune 500) recently announced layoffs of nearly 25,000 over the next three years, as a result of the acquisition of systems integrator EDS. It sounds like bad news - and for those about to lose their job, it truly is - but it doesn't really speak to the health of the company. A week after the layoff news, HP announced its own buyback plan: $8 billion (or roughly the amount the company will save from the layoffs).
Oracle has $11 billion in debt as a result of a years-long acquisition spree, but it also holds $13 billion in cash, and co-president Safra Catz remains relatively unconcerned with all the bad news. Yes, Oracle (ORCL, Fortune 500) sells plenty to beleaguered financial institutions, and it's logical to assume that the company will take a hit, but Catz thinks Oracle's products and high-profit service contracts will be the last things to be cut from operating budgets. "The company has so much momentum, such a broad product line, that if a customer is buying, they are much more likely to buy from us. If they've got to decide something not to spend on, it's probably something that's a little bit less strategic and less important," Catz said in a recent analyst conference call. Google (GOOG, Fortune 500) CEO Eric Schmidt echoed the sentiment, telling reporters, "It's business as usual at Google."
And yet it's still early. If the dot-com collapse is any guide, things could get nasty. In 2001, for example, Sun Microsystems (JAVA, Fortune 500), was impaled when bankrupt customers sold assets - including Sun servers - at auction. Sun then lost another set of customers when the survivors decided it was better to buy used. That could certainly happen again.
When asked what he thinks of the morass on Wall Street, Bill Watkins, CEO of the $13 billion disk drive and server maker Seagate, lets fly a characteristic quip: "Can you get them to stop short-selling my stock too?" But upon deeper reflection, he's clearly concerned about the emergence of a gray market. "Fifteen to 20% of our enterprise business probably sells into Wall Street," he says. "What we're worried about is whether people are going to start selling their assets off. The good news is that there's so much trading going on. All that data has to be stored and backed up and saved."
Further down the food chain, things get even more worrisome. Newer companies or those with relatively experimental technologies may be vulnerable to being considered nonessential. And more established but undercapitalized private companies could be in real trouble. The IPO window has been shut for a while, and the Wall Street turmoil means it ain't opening anytime soon.
A serious dearth of public market "exits" puts late-stage VCs in a real bind, as well as established private companies with a lot of bills to pay. (God help you if you're, say, a young server-farm company.) "The worst place to be is a late-stage company with a high expense rate, selling products primarily into the U.S. market," says Peter Rip, general partner of Crosslink Capital in San Francisco, which operates both a venture firm and a hedge fund. "That's just a seriously bad place to be, and money is going to get really expensive for those companies." Early-stage VCs may be better off, but with later-stage money drying up, they're faced with holding on to their investments longer and squeezing more out of them. Likewise, as angel investors see their wealth squeezed, they'll probably back off seeding so many startups. In short, everyone gets more conservative.
The hottest sector on Sand Hill Road lately has been alternative energy. Since those companies require huge infrastructure investments, it's easy to imagine the green-tech bubble popping. But outside factors are at play here. "Clean tech is not just a nice thing to have; it's something that has to be done," says Mark Heesen, president of the National Venture Capital Association. "The government is demanding it. Consumers are willing to pay extra for a better world."
And so are investors, for now. Just as Lehman was going down, SolarReserve, a solar power company, announced a $140 million round of funding from, among others, Citigroup and Credit Suisse. The transformation of Goldman Sachs and Morgan Stanley - both big green investors - into bank holding companies apparently won't alter their environmental strategies. "In terms of our renewable-energy investing business, there's no change," says Goldman spokesman Michael DuVally.
But companies that rely on bank financing will feel pain, according to Ethan Zindler, head of North American research for New Energy Finance. "We've already seen some pullback for some big solar and wind deals," he says. "Bigger developers who have solid balance sheets will be okay, but the smaller guys could be in trouble."
That is likely to hold true in all sectors. If Microsoft's $40 billion buyback plan says anything, it's that the company couldn't find a better use for its money. If the sentiment infiltrates Microsoft's peer group, then acquisitions will surely slow. And that's nothing but grim news for the myriad feature-oriented Web startups that were founded mainly to be acquired by Microsoft, Google, and Yahoo. If the Web giants stop buying, a lot of Web 2.0 fruit will die on the vine.
But while death and failure are part of the Valley psyche, so too is optimism. Peter Thiel thinks people are overreacting to the crisis. "I strongly think that for the next few months, equities, especially financial stocks, move higher," he says. "People are just way too bearish on the U.S. right now."
He's even more bullish on the Valley. "We have this leverage finance bubble like we had in the '20s, and there's an argument that we're headed to something comparable to the '30s," he says. "Where was the best place to be in the '30s? Probably Los Angeles. It was the hub of new media and technology, with the radio and the airplane. Silicon Valley is the L.A. of the 1930s."
But will entrepreneurs, the lifeblood of the Valley, still come if the money's drying up? "If anything," Thiel says, "we'll have a lot more talented people going into things like real engineering, as opposed to financial engineering."