Clouds loom over tech sector

Some worry broad economic woes may finally show up on the balance sheet of big tech firms. Meanwhile, Silicon Valley veterans say a lengthy downturn could have broad, but not catastrophic impact on the start-up economy.

Ina Fried Former Staff writer, CNET News
During her years at CNET News, Ina Fried changed beats several times, changed genders once, and covered both of the Pirates of Silicon Valley.
Ina Fried
4 min read

Those watching for signs the overall economic woes are affecting the tech industry may not have to wait much longer.

Although many big tech names say they have yet to see a direct impact (beyond the dip in their stock prices), one analyst I talked to said that it's typically not until the end of the quarter that such warning signs crop up.

Well, in addition to being St. Patrick's Day, it's also two weeks before the end of the first quarter and the time to start watching for negative earnings pronouncements from companies that realize their quarter is not shaping up the way it should be.

"I think it's going to make the markets increasingly nervous as we begin to see some of these tech companies (warn)," said the former Wall Street analyst, who now works on the buy side.

The analyst cautioned that we are likely to see mixed reports initially, with some companies seeing challenges and others not seeing any signs of a slowdown.

Whether start-ups feel the pinch depends a lot on in what stage they are in their funding. The IPO market is essentially shut, the analyst said. That means that you have a whole group of companies that were hoping to go public that are instead going to be looking to either get acquired or land mezzanine funding until the market improves.

"Valuations have been softening, but the bottom hasn't fallen out."
--Tom Vertin, Western Division manager for Silicon Valley Bank
"Valuations have been softening," he said, "but the bottom hasn't fallen out."

However, some start-ups may find it easier to get bought in this market. With credit tightening, some large companies may shift from debt-fueled megadeals to strategic acquisitions, according to Mike Shepherd and Laurie Yoler, at GrowthPoint Technology Partners, a boutique Silicon Valley investment firm.

An example of this dynamic is BMC's acquisition of BladeLogic for $800 million this morning.

"It wasn't done at the highest (price) but it still was a premium," said Shephard.

Tom Vertin, Western Division manager for Silicon Valley Bank, said he is still seeing some appreciation in values for the companies in the hottest areas or with the top management, though valuations have started to weaken for the next tier of companies.

"Valuations have been softening," he said, "but the bottom hasn't fallen out."

One thing that helps to buttress the tech sector is its reliance on venture capital. Many VC firms have already raised a significant amount of money and are unlikely to return it to investors simply because of a downturn. VC firms also plan ahead for their portfolio companies, typically reserving money that will be needed down the road.

Alain Harrus, a partner at equity firm Crosslink Capital said that the credit crunch will likely dent the valuation of late-stage private companies. These companies will be unable to go public and also be compared against their public counterparts, which are declining in value. Hot private companies will still be attractive, in other words, but maybe not as expensive.

"Late stage valuations will start suffering," he said. "It doesn't change the investment dynanmics, just the economics."

One issue that has received ample discussion is the notion that some Silicon Valley companies may have been a little too reliant on a type of investment known as auction-rate securities. Though pitched as a higher yield alternative to cash, the once highly liquid investments have proved less so in recent months as there have been fewer bidders in the auctions that give the funds their liquidity.

Anxiety on that front, though, has eased as the problem appears to be less widespread than once feared.

"Those horror stories are out there (but) the number is not that great, that we've been able to see," Vertin said.

Still, the change in economic winds has some entrepreneurs decidedly less optimistic than they were. "There's an equal likelihood that within the next ten weeks we will either get acquired, get funding, or go belly-up," said a CEO of one start-up looking to pull in its first post-angel round of funding.

Not everyone stands to be crunched equally. The aforementioned former Wall Street analyst notes that enterprise companies are likely to get hit sooner than consumer ones, with both software and hardware firms at risk.

Although it certainly has a large enterprise business, Microsoft may still be a good bet in uncertain times, Jeffries analyst Katherine Egbert said in a research note on Monday.

"Seek safety in Microsoft's numbers," Egbert said in the note, saying that, following its recent decline, Microsoft shares represent a "solid refuge."

On the flip side, those likely to be hit hardest are technology firms that cater exclusively to the financial services industry or get a lot of their revenue there. "That's a subset that is probably going to get hammered," Vertin said. "I am aware of a number of software and software-as-a-service companies that have had contracts delayed or stopped altogether."

We can also expect to see a shift in the way technology companies market their products, with a renewed focus on how the gear in question can cut costs and help the bottom line.

"Technology is a lagging indicator. As we dive into a recession, it gets hot again," asserted Shepherd. "People are looking for efficiencies and they look to technology as a way to cut heads, lower consumption of energy (and) reduce waste."

How long the woes will last is an open question, but Vertin suggests the challenges are neither likely to persist for years nor resolve themselves overnight.

"We are going to have this credit crunch, if you will, for the next six to 18 months," he said.

News.com's Michael Kanellos and Caroline McCarthy contributed to this report.