Here’s What I’m Worried About with the Everything Bubble
How cash-burn machines power the real economy, and what happens to the economy when investors refuse to have more of their cash burned.
This is the transcript from my podcast last Sunday, THE WOLF STREET REPORT:
I’m not going to call it “tech,” because most of the startups in that so-called tech space aren’t tech companies. They’re companies in mundane businesses. And many of these companies aren’t startups anymore but mature companies that have been in business for over a decade and now have tens of thousands of employees. And then there is the entire shale-oil and gas space that has turned the US into the largest oil and gas producer in the world.
They all share two things in common:
- One, they’re fabulously efficient, finely tuned, and endlessly perfected cash-burn machines.
- And two, investors in these companies count on new cash from new investors to bail out and remunerate the existing investors.
This scheme is a fundamental part of the Everything Bubble, and there is a huge amount of money involved, and it has a big impact on the real economy in cities where this phenomenon has boomed, and everyone loves it, until these hoped-for new investors start seeing the scheme as what it really is, and they’re suddenly reluctant to get cleaned out, and they refuse to bail out and remunerate existing investors. And suddenly the money runs out. Then what?
Calling these companies “tech” is a misnomer, designed to create hype about them and drive up their “valuations.” They engage in mundane activities such as leasing office space, running taxi operations, doing meal delivery, producing and selling fake-meat hamburgers and hot dogs, providing banking and brokerage services, providing real estate services, and renting personal transportation equipment, such as e-bikes and e-scooters.
And let’s just put this out there right now: e-scooters appeared in public for the first time in the late 1800s, along with electric cars and trucks.
Then there is the endless series of new social media platforms, in addition to the old social media platforms of Facebook, Twitter, WhatsApp, Instagram, and the like, where people post photos, videos, promos, and messages about whatever.
That’s the “tech” sphere mostly today.
There are some tech startups in that group, however. And that technology is about spying on Americans and others and datamining their personal events, purchases, and thoughts to be used by advertisers, government intelligence agencies, law enforcement agencies, political parties and candidates running for office, and whoever is willing to pay for it.
And there is some real tech work going on in the automation scene, which includes self-driving vehicles, but most of this work isn’t done by startups these days – though some of it is – but by big companies such as Google, big chipmakers such as Nvidia, and just about all global automakers.
And there is a slew of big publicly-traded companies that have stopped being startups years ago, that are burning huge amounts of cash to this day, and that need to constantly get even more cash from investors to have more fuel to burn. This includes Tesla, which succeeded in extracting another $2.7 billion in cash in early May from investors. Tesla duly rushed to burn this cash. And it includes Netflix, which extracted another $2.2 billion in April. From day one, these companies – just Netflix and Tesla – have burned tens of billions of dollars in cash and continue to do so, though they’re mature companies.
And it includes Uber which received another $8 billion from investors during its IPO in May, which it is now busy burning up in its cash-burn machine.
Don’t even get me started about the entire shale oil-and-gas space – though there is some real technology involved.
That entire space has burned a mountain of cash. Many of these shale oil companies are privately owned, including by private equity firms, and it’s hard to get cash-flow data on them. But for example, just to get a feel for the magnitude, by sorting through 29 publicly traded shale oil companies, the Institute for Energy Economics and Financial Analysis found that between 2010 through 2018, $181 billion in cash was burned. In 2019, they’re burning an additional pile of cash because oil prices have plunged again. And shale drilling started on a large scale before 2010. Plus, there’s the cash burned by the privately held companies. So, the total cash burned is likely in the neighborhood of several hundred billion bucks.
These companies and industries are “disruptive.” They claim that they change, and some of them actually do change, the way things used to be done.
But they have not figured out how to have a self-sustaining business model, or how to actually make money doing it. It’s easy to quote-unquote “disrupt” an industry if you can lose billions of dollars a year, if you keep getting funded by new investors, while everyone else in this industry would go bankrupt and disappear if they used a similar business model.
The only reason these companies have had such growth is because investors didn’t care about the business model, profits, and positive cash flows.
All these investors cared about is the likelihood that the cash-burning company would be able to raise new money from new investors, such as by issuing new bonds or new shares, so that it could pay off and remunerate the existing investors. And existing stockholders counted on this new money to keep the company afloat and share prices sky-high.
Some companies, such as WeWork, are now running into trouble with this scheme. And the unicorns that recently sold shares to the public via IPOs have seen their share prices plunge. So there are signs that the appetite for these schemes is no longer as rampant as it was just last year.
But other companies are still able to raise new money from new investors to pay off and remunerate existing investors and keep their share prices high that way, and these new investors are still lining up to fund much of it.
This scheme is a key feature of the Everything Bubble. And it has had a large impact on the real economy.
When a company has a negative cash flow, which these companies all do, it means that they spend more investor money in the real economy than they take out. This acts like a massive stimulus of the local economy and even of the broader economy.
They’re paying wages, and these employees spend those wages on rent or house payments, on cars, electronics, food, craft beer, shoes, and they’re becoming bank customers and buy insurance and go to restaurants and pay taxes at every twist and turn. Few of those employees end up saving much. Most of them spend most of their wages, and this money goes to other companies and their employees, and it gets recycled over and over again, allowing for more hiring and more wages and more consumption to percolate through the economy.
Some of this money that is circulating comes from revenues, and is thereby extracted from the economy to be recycled. But the rest of the money – the amount that companies spend that exceeds their revenues, so the negative cash flow – comes from investors. And this is pure stimulus.
This is how the $10 billion that Softbank sank into WeWork was and will be recycled via salaries and office leases and purchases, and via local taxes, and purchases of furniture and decorations and rehabbing offices whereby the money was recycled by construction crews and electricians and flooring suppliers. Softbank’s money was routed via WeWork into the various local economies where WeWork is active. And it helped pump up commercial real estate prices and office rents along the way.
The shale oil-and-gas sector spends a lot of the negative cash flow in the oil patch, but also the locations where the equipment they buy is manufactured, such as sophisticated computer equipment, the latest drilling rigs, big generators, high-pressure pumps, and the like.
So an oil driller in Texas will transfer some investor money to manufacturers in distant cities. And the employees at these manufacturing plants buy trucks and boats and used cars, and they buy houses, and all kinds of stuff, and all of those hundreds of billions of dollars that investors plowed into the industry got transferred and recycled endlessly.
This is the multiplier effect of investors plowing their cash into money-losing negative cash-flow operations.
So what happens when investors figure out that this money is gone, and that any new money they might give these companies will also be gone?
What happens when these investors realize that the ever-larger amounts of new money that must come in behind them to bail them out and remunerate them might not come in behind them?
What happens if these investors fear that they might get stuck with their bonds and equity stakes, and might become the end-users of them because there is no one coming in behind them? And that they have a good chance of getting crushed in the process?
It’s all a mind-game.
Investors are already contemplating this scenario. It has a chilling effect.
Don’t get me wrong: there is still lots of money out there chasing down these companies, and WeWork might yet get bailed out albeit at a far lower valuation than in years. Softbank and JPMorgan are both working on ways to salvage their existing investments and loans in WeWork, and the only way they can do that is by throwing good money after bad. Both of them are now trying to use other people’s money for that purpose.
So, it’s not yet the sudden end of the Everything Bubble. This is a process and takes time. But as this process moves forward, and as new investors are becoming more reluctant to bail out and remunerate old investors, those billions of dollars in cash that investors feed into these cash-burn machines will slow.
In turn, these companies will cut their spending, including spending on advertisement and promos on social media sites – many of them also startups. And they will cut their employees in waves, such as Uber and WeWork and others are already doing.
And eventually many will shut down when they run out of money, leaving investors high and dry. That investor-money that got endlessly recycled in the economy, won’t be there to be recycled. The employees who’d recycled this investor money by spending most of their wages, well, they’ll be out there looking for jobs and cutting their spending to the bone, or moving back in with mom and dad a thousand miles away.
The restaurant and bar scene will go through a shakeout. Suddenly qualified kitchen staff will be easier to hire, but then no one is hiring. Landlords will be turning over properties to lenders. Commercial Mortgage Backed Securities will teach investors some valuable lessons. And so on.
Each step triggers the opposite of the multiplier effect derived from investor-funded cash-flow-negative companies. And this is why the dotcom bust was so rough on San Francisco, Silicon Valley, and other hotspots of the startup scene.
As the current startup-unicorn-bubble and shale-bubble unwinds, it will have a sobering effect on the real economy in those hotspots, and to a lesser extent on other parts of the economy. That kind of investor craziness we have seen in recent years was a lot of fun all around, but unwinding it is not fun.
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