After the gold rush: technology investing in the post-modern era
IN PRINT ARCHIVE CIR Summer 2001
|After the gold rush: Technology investing in the postmodern era|
|Changes in the technology capital markets carry important implications for pension sponsors.|
|By Philip J. Olsson, Managing Director, Private Equity, Altamira Investment Services|
Technology didn't crash. A special class of financial assets--technology stocks--crashed after a decade of very inexpensive capital that created excess capacity.
Low interest rates caused high valuations for long-dated securities. The longest-dated securities are technology stocks, whose future cash flows are uncertain. Assumptions were wrong, but there was some arithmetic underlying the technology stock boom. Excess liquidity also flowed into low-quality assets, such as Internet stocks of little merit.
When interest rates rose, the structure began to wobble. When it became clear that excess capacity meant lower capital spending, a financial asset crash occurred. Many investors sustained significant losses, but few suffered insolvency. We are not on the verge of a second Great Depression.
Innovation continues, but adoption rates have slowed. Much of the new technology was directed at start-up telecommunication companies. Most of these have no access to capital. Incumbent telecom carriers are not typically early adopters of technology.
Meanwhile, the global network expands and demands innovative solutions. The relevant discussion is the rate of adoption of new technologies, not whether they will be created.
Quite obviously, private market valuations are down. The magnitude of the drop is probably at least 50%, and as much as 75%, depending on the sector.
Venture capitalists are returning to basics. They are supporting managers in building value (translation: create earnings and cash flows) over three to five years, rather than packaging hot initial public offerings. Now that private equity providers aren't competing by bidding up valuations, the key criteria for access to deals are an ability to add value, financial staying power and technical expertise.
Some commentators ascribe a significant component of returns from private equity to inefficiency. The author disagrees, but no matter what one's view, emerging signs of efficiency in private markets bear watching. There are several reasons for this trend.
Sponsors are also enforcing some discipline on private equity managers to adhere to style and selection disciplines, arguably making investment decisions more predictable.
The growth of the business also pushes the private equity markets toward efficiency. The venture capital business is becoming more institutionalized as more money is raised and a range of generalist and specialized managers establish themselves. Even though there is no centralized marketplace, the private equity industry is assuming some of the characteristics of an organized market.
It is also interesting to observe the impact of incentive compensation, which is pulling highly trained professionals away from traditional asset managers into private equity and hedge fund management.
Sponsors and their managers often remark on the modest role of Canada in global capital markets. In technology this observation is incorrect.
Canadians have developed many technologies to support a sophisticated infrastructure. The consequence is global leadership in areas such as optical networking, network management software, wireless transmission and digital media. The maturation and sale of several technology startups have created a class of technology entrepreneurs. This feeds a pipeline of early-stage opportunities that organized venture capitalists finance in turn as companies grow. Canada's borders are not closed to foreign investors, but proximity and local knowledge create appealing opportunities for Canadian sponsors.