A New Tech Boom Gathers SteamAs we’ve just explained, when the housing market cools, the stock market will heat up.
And what will be the hottest sector of the market? Information technology.
Obviously, we’ve seen this before. Dot-com mania created fortunes from little more than silicon, HTML code, and feverish imaginations.
Aside from a few pioneering companies like Google, Yahoo, Amazon, and eBay, most of those businesses never turned a reasonable profit, and many quickly crashed and burned.
But look around the Internet now, and you’ll see that the reality of the Net finally lives up to the hype we heard in the ‘90s.
The number of Internet users throughout the world reached 1 billion last year.
The technology has evolved from a novelty to an indispensable part of everyday life.
At this moment, millions of people are using the Web to download music legally, upload their photos from their digital cameras, pay their bills online, search for products, and buy everything from notebook computers at Dell.com to diamond necklaces at BlueNile.com.
This isn’t another bubble stretched beyond the boundaries of reason.
This is the inevitable next stage in the progression of any revolutionary technology.
Whether it is the airplane or the cell phone, whether it is the railroad or the music download, every important, disruptive technology goes through a series of phases from boom to bust to build-out.
During the pioneering boom phase, entrepreneurs, investors, and users get their first glimpse of the technology’s potential.
However, the euphoria over what it could be overwhelms what the technology is at that point; investors throw money at anyone with a business plan, and competitors swarm into the market.
Ultimately, the technology is too primitive at this stage to live up to the wildly inflated expectations of users and investors alike, and the market for the pioneering technology crashes.
During the bust, many of the competitors go out of business or consolidate, and only a few strong businesses survive as the pioneering phase comes to an end.
During the next stage, the build-out, the surviving pioneers are joined by second movers ? established companies that focus on using solid business plans to commercialize the technology.
It’s also at this point that the infrastructure needed for the technology, as well as the supplementary products and services that are needed to support the technology, become established.
As a result, the technology deeply penetrates the market and strengthens the economy.
It was during the build-out phase of the automobile industry that its technology took off.
At that point, users could drive cars on paved interstate roads; safety improved because traffic was controlled by stoplights; and cars could be used in winter because of the introduction of heaters.
For the Internet, the primary difference between the pioneering boom phase ? which led inevitably to the bust ? and the build-out phase we’re in now is that high-speed connections are now widely available.
In the days of the 56K-baud modem, Web pages loaded slowly and downloading a digital video file could take hours.
Today’s broadband connections are letting users capture more value from their use of the Internet, in the same way that paved highways allowed drivers to realize the potential of cars.
According to the Pew Internet and American Life Project, the number of Americans who have high-speed Internet connections at home has exploded, from 5 million in 2000, to 73 million at the end of 2005.
As Fortune1 reminds us, the high-speed Internet phenomenon has unleashed the potential of Web-based business plans.
Apple raked in $4.5 billion in sales from its iPod in 2005, thanks to the iTunes Music Store, where users have downloaded an average of 333 million songs a year over the past three years.
Google expects to earn $3.7 billion in profits in 2007 from the advertising it sells on its popular search engine.
A report in Financial Times2 includes a Deutsche Bank estimate that advertising on search engines will become a $25 billion a year business by 2009.
Meanwhile, Silicon Valley is once again sizzling with energy, ideas ? and cash.
A survey by the San Jose Mercury News3 revealed that the valley’s 150 biggest publicly traded firms achieved record profits and revenues in 2005.
The total market capitalization of those 150 companies surged by 23 percent to $1.2 trillion by the end of March 2006.
They also increased their workforces substantially for the first time since 2001, adding 38,000 people.
And their top executives earned $2.6 billion in pay for 2005, the most since the boom.
So how can we be sure that this is not another bubble? Here are three reasons:
First, companies are not rushing to launch IPOs before they earn a profit.
Due to the fallout from the tech boom and bust earlier this decade and the new Sarbanes-Oxley rules, it’s become much harder to run a public company, so there aren’t as many entrepreneurs who are eager to face that scrutiny.
And, according to BusinessWeek,4 there’s significantly less capital being invested in tech companies than during the dot-com boom.
Fifty-six Internet companies raised $4.5 billion by going public in 2005, which is far less than the 223 dot-com IPOs in 1999 that netted almost $18 billion.
Second, when Internet companies do go public, their share prices remain more in line with profits than in the past.
Google, at a recent share price of $400, trades for 33 times the Street’s consensus estimate of its earnings next year.
That’s not exorbitant when you consider, as Fortune5 points out, that the venture incubator ICG traded for 400 times its next-year sales in 2000.
Third, the startup costs for a profitable business are much lower than they were just five years ago.
Prices of hardware have fallen thanks to Moore’s Law. Open-source software has eliminated the hundreds of thousands of dollars in licensing fees entrepreneurs once paid for software.
And the outsourcing movement ? which could only flourish once the build-out of the Internet had begun ? has brought an endless supply of cheap overseas labor to high-tech jobs that once could be done only by an elite group of bleary-eyed programmers fueled by Red Bull in Silicon Valley.
According to a McKinsey & Company study cited in Newsweek, American companies will hire 1.5 million workers in India by 2008.6
Looking ahead, we foresee the following three developments:
First, investors who make smart buys in the Internet sector will be rewarded with big gains.
Fortune recommends buying Yahoo!, the Internet portal that appears ready to gain more market share for its search engine;
Navteq, the software firm that provides on-line mapping services to Mapquest, Yahoo!, and Google; and Akamai Technologies, which uses servers to increase the speed of Web pages.7
Its other top picks include Cisco Systems, which recently bought cable box maker Scientific-Atlanta and seems poised to be a huge player in supplying Internet video services; and News Corporation, the traditional media company that purchased MySpace last year and now has access to its 65 million users.
Second, as Internet stocks post gains, stock options will become a hot topic in compensation once more.
Executives of tech companies are finally finding it profitable to cash in their options for the first time since the boom ended.
A report in The Wall Street Journal Europe8 reveals that Yahoo’s CEO, Terry Semel, cashed in $173 million in options in 2005 and $229 million in 2004, a huge jump from the $25 million in options he exercised in 2003.
In fiscal 2004, the most recent year for which statistics were available, the Journal found that the CEOs at the 150 largest public companies in Silicon Valley cashed in options worth nearly $1.6 billion, an increase of 50 percent from 2003 and 177 percent from 2002.
Not only will that inspire other companies to increase the options they offer to their own executives, it will have another impact:
The options windfall is likely to breathe new life into the sagging real-estate market in Silicon Valley, where high-end homes will once again be in demand.
As a realtor explained to theJournal, “It’s the stock option people . . . who are still buying [homes in the $2.5 million to $7 million range].”
They are also largely responsible for boosting spending on home remodeling in the region, which has increased to $446 million in 2005 from $331 million in 2001.
Third, despite the billions of dollars in profits already earned by a few leading companies during the build-out phase, the Internet still hasn’t even approached its full potential.
Consider that only 5 percent of advertising spending is allocated to the Web.
As the number of people online continues to grow, and as the share of their free time that they spend online increases, traditional advertisers will finally begin to devote a larger share of advertising budgets to targeting Internet users.
Based on the total annual spending of $575 billion on advertising worldwide, if the Internet captured just 15 percent of the total by 2010, that would represent an increase of $57.5 billion in revenues for the sector, and there is plenty of room for continued growth.
References List :
1. Fortune, May 1, 2006, “The Boom Is Back, ” by Adam Lashinsky. ⓒ Copyright 2006 by Time Warner, Inc. All rights reserved.
2. Financial Times, January 25, 2006, “Boom to Bust and Buzz Again,” by Richard Waters. ⓒ Copyright 2006 by The Financial Times Limited. All rights reserved.
3. San Jose Mercury News, April 10, 2006, “Valley Steps Up Its Rebound,” by Chris O’Brien and Jack Davis. ⓒ Copyright 2006 by San Jose Mercury News. All rights reserved.
4. BusinessWeek, May 22, 2006, “It Feels Like 1998 All Over Again,” by Justin Hibbard and Heather Green. ⓒ Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
5. Fortune, May 1, 2006, “The Boom Is Back, ” by Adam Lashinsky. ⓒ Copyright 2006 by Time Warner, Inc. All rights reserved.
6. Newsweek, March 6, 2006, “Outsourcing: Silicon Valley East,” by Keith Naughton with Brad Stone. ⓒ Copyright 2006 by Newsweek, Inc.
7. Fortune, May 1, 2006, “The Boom Is Back, ” by Adam Lashinsky. ⓒ Copyright 2006 by Time Warner, Inc. All rights reserved.
8. The Wall Street Journal Europe, March 16, 2006, “Wealth: Silicon Valley Resumes Cashing in Options,” by Pui-Wing Tam. ⓒ Copyright 2006 by Dow Jones and Company. All rights reserved.
