Estimates of the capitalization of technology companies in 2016: the end of troubled times - time of unsustainable growth

What is happening in technology investment now? Again 2001, when the technology market collapsed? Or 2008, when the whole world collapsed, but the technology broke through? Or as with Facebook in 2012 - a surge in the assessment of capitalization and a chance to buy?
Anecdotes about "dead unicorns" are not accepted. The explanation should start with a structure and a qualitative description of what drives the markets - then fill this model with data. This is my model and my data.

Capitalization estimate + investment = market engine

Venture startups live in a crazy hypercyclical world under the influence of the constant and interrelated dynamics of investment and capitalization estimates. It is easy to look like a respectable retired politician, “concerned about high investments” or “concerned about high valuations”, but tolerance to investing and willingness to pay for rapid growth are key aspects of the entire venture capital model.
The question is always whether the invested funds create sufficient real value (revenues, customers, etc.) to justify the high valuation of capitalization. From this position, an absolute estimate of capitalization (billions of dollars, “yes” or “no”) is not the measure that would be worth using. It represents a way out, not an entrance - and is extremely prone to emissions in any direction, which is clearly shown by the last five years. At that time, the capital markets were “in love with the heat” of growth.
Rapidly growing companies earned a high valuation of capitalization, which allowed them to increase capital and direct it to further growth, which again led to an increase in the valuation of capitalization. The result is an endless cycle of high investment, higher growth, even higher capitalization estimates - in general, a loop with strong positive feedback.

Bubbles grow slowly, but collapse quickly.

This pushes companies to maintain growth at all costs. Since the number of profitable ways to invest money in each company is finite, at some point the pressure pushing to growth leads to investments that, indeed, provide growth, but at the expense of profit. Unprofitable sales channels, customer acquisition subsidies and expensive advertising campaigns are signs that the company is focused on growth at any price, and not on growth with profit. Companies become imprudent.
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Problems appear through numbers ...

The basic financial model for each technology company is the same: spend a certain amount on research and development (R & D) of a product, then invest in sales and marketing to earn revenue. The hope is that (ultimately) the income received from customers, minus the costs required to acquire these customers, will be large enough to cover R & D and other expenses, and the company can be profitable.
This is the reason why all the talk of “investing” is quickly turning into talk about customer profitability. All other costs are roughly fixed, but the speed at which the cost of selling products gives income from the customer is a key financial indicator for a company. If something goes wrong, it will show up here.
Consider an example. For SaaS companies (Software as a Service = Software as a Service) in which I invest, the most simple and most accessible measure of client profitability is sales efficiency, i.e. the ratio of quarterly revenue growth to sales and marketing costs required to generate such growth. The chart below shows the average sales performance of all public SaaS companies in 2012-15.

The time of unsustainable growth will end.
Steady adjusted growth will return.

It is a key capitalization measure for these companies and has been declining quite consistently since 2012 (currently it is about 35 percent below the peak, with the rate of decline increasing). This is a serious matter. Customer profitability is a transmission mechanism from investment to growth and from growth to the estimation of capitalization. This key indicator has plummeted as more money has been injected.

Estimates of capitalization collapsed 18 months ago

Exchange platforms with difficulty, but realized this 18 months ago. Returning to the same public SaaS companies: the chart below refers to the top 25 percent of these companies ranked by their growth, and shows how the assessment of their capitalization has changed over time.
In March 2014, the capitalization of these fast-growing companies was estimated at the amount of 12 potential annual revenues, but in the middle of the same year it dropped to 6, where it remains to this day. The long awaited collapse has actually already happened - almost 18 months ago.

This pair is interconnected.

Either you believe in striking coincidences, or it is clear that these two graphs are related to each other. Unlike private equity markets, public markets have the opportunity to rethink investment decisions every day. Over time, an unlimited number of investors, explicitly or implicitly, made it so that the client's profitability and the quality of growth decreased and, consequently, the premium for increased growth decreased. Capitalism works.
Private capital markets, making decisions only once a year, react more slowly; therefore, the lack of IPOs and price regulators has led expensive private companies to enter public markets.

Now what?

In 2016, any private technology company, where the last percentage points of growth were obtained only at the expense of profits, will no longer be able to raise capital with a high valuation of capitalization. Prudent companies will react by reducing unprofitable investments, thus raising sales efficiency — even reducing the growth rate.
Then we will see the work of the same feedback loop, but in the opposite direction. A lower valuation of capitalization will lead to a decrease in attracted capital, which will entail a decrease in growth and an even lower valuation of capitalization. In contrast, a rise will be much faster. Bubbles grow slowly, but collapse quickly. Ultimately, after reaching the lower limit, recovery will begin, as growth rates become sustainable at acceptable levels of customer profitability. The time of unsustainable growth will end. Stable adjusted growth will return - at least until the next time.

Losses and casualties along the way

The new end state will be good, but the transition will be difficult. Some companies will leave the old path too late to have time to switch to another, and lose their money. Even for the overwhelming majority of companies that have time to make the necessary turnaround, managers and investors devote one or two years to what is euphoniously called "growing into the valuation of capitalization." This, in other words, means that it will be necessary to work hard without any additional return!
This is not 2008, which turned out to be very bad for the business community as a whole, but rather gracious for technology; this is not 2001, the year of the "massacre" for technology companies; and this is not Facebook 2012 - panic from nothing. The industry clearly overpaid for pretty good companies and overestimated them. Now everyone involved in this process should heal their wounds and return to the world, albeit a slower growing one, but more healthy. But this is not the worst thing that could happen.