Why are tech stocks declining?

Shares of loss-making tech companies have continued to slide as the hunt for yield slows and investors turn to less risky assets. Both public and private market valuations have skyrocketed over the past few years, especially for tech and crypto companies. However, with expectations of faster-than-expected Fed monetary policy tightening, investors began to reduce their exposure to risky assets.

Companies such as Netflix, Peloton and others saw shares fall nearly 20% during trading hours. Netflix’s 20% drop slashed $45 billion from investor value.

India also saw shares of Zomato, Nykaa, Paytm and PolicyBazaar fall below their listing prices. FreshWorks, India’s most popular software-as-a-service company, fell 50%.

Why are tech stocks declining?

One way to explain the decline in these stocks could be that investors had invested in these markets on the basis of growth, that is, future income. As rates rise, discounting cash flows that lie in the future causes the present value to decline.

Additionally, growth can sometimes be overestimated, as in the case of Netflix, where management has forecasted significantly lower growth going forward.

Peloton Interactive saw its stock plummet as the company decided to halt production of its sports equipment. She decided to reorganize the organization with a focus on restructuring costs – a task for which she hired McKinsey. The decision was rooted in a drop in demand for Peloton’s products. Although the consensus estimated a drop in demand for Peloton’s product at the end of the pandemic, the severity of the drop was surprising.

Another way to look at the downside could be a shift towards safer assets, with investors moving away from risky assets as the risk no longer justifies the return. An index compiled by Goldman Sachs that tracks unprofitable tech companies is up around 10% this year as investors continue to turn to “old economy stocks” – banks, insurance and industrials.

In India, tech IPOs, which offered handsome returns to their investors upon listing, have been on a downward trend over the past few months. After its lukewarm IPO, Paytm saw the biggest decline, nearly 38% from its listing value. The drop could negatively impact the IPOs of other tech companies such as OYO and others that have filed their first IPO documents.

Blank check companies cancel IPOs

The United States has seen blank check companies cancel their IPOs before. Special Purpose Acquisition Vehicles (Spacs) raise funds from public shareholders and then acquire companies, primarily in technology and healthcare. The popularity of Spacs was evident from the fact that these offerings raised as much money as traditional IPOs in 2020.

However, as market sentiment for these companies begins to wane, the Spacs decided to pull out of the proposed IPOs. In total, over the past 20 days, about seven Spacs have written to the United States Securities and Exchange Commission about their intention to cancel their IPOs. These companies have accumulated $2.5 billion.

The decision to pull out can be attributed to lower investment interest, poor past performance, regulatory scrutiny and scandals. A growing number of shareholders are also demanding reimbursement, a trend that does not bode well for Spac’s founders.

Private market valuations may correct

Private market valuations are also expected to decline as public markets set lower valuation metrics. Rajan Misra, managing director of Softbank Vision Fund, said private markets were overvalued and if public markets were to remain at current valuations, private market valuations would correct.

“If the public markets stay where they are, then the private markets, which are overvalued, have to rebalance. And we are already seeing that,” Misra said.

Shailendra Singh, Sequioa’s managing director for India and South Asia, backed Misra’s view on Twitter. In a tweet, Singh said a “much-needed” valuation correction would be healthy for the start-up environment. India saw the highest number of unicorns created in 2021, with 40 companies across all industries reaching the $1 billion valuation.

In total, Indian startups raised a record $36 billion from investors in 2021 at high revenue multiples as investors expect rapid growth. With two of India’s most influential start-up finance players signaling that private markets are overheating, deals are likely to slow and start-ups will reach reasonable valuations.

It’s possible that tech stock valuations will experience a timing correction or price correction, until fundamentals catch up.

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