Nov 12, 2015 ยท 5 minutes

To get a sense of what the tech landscape may look like if, as expected, the capital markets dry up next year, consider Angie's List.

Angie's List went public at $13 a share four years ago, rose as high as $28 a share in 2013 and fell as low as $4 a share last June. Earlier this week, the stock jumped as much as 13 percent back near $9 a share after IAC/InterActive Corp. (a company so good they named it twice) offered to buy it at a 12-percent premium to its market value at the time.

The board of Angie's List politely said no. But investors signaled their thoughts on the proposed buyout by bidding up not only Angie's List but also Yelp. The message was clear: In this tech market, there is no longer a rising tide lifting all boats. There are the strong, and there are the weak. And the strong are getting ready to eat the weak.

If you look back at the performance of technology companies in 2015, you can see a pretty definite bifurcation of the two groups. Many of the better-known consumer tech companies are faring poorly: Yelp is down 54 percent, Pandora 25 percent, Twitter 26 percent and Yahoo 34 percent.

Contrast that to the biggest consumer tech companies, those that have been able to deliver strong revenue and profit growth: Alphabet and Facebook are both up 40 percent, Microsoft is up 15 percent, Amazon is up 117 percent and Netflix is up 131 percent. Apple is up a more modest 5 percent, but remember that Apple had two pretty spectacular years in 2013 and 2014.

What's happening is that investors are growing jittery at the thought that the Fed will start to raise interest rates later this year or early next year. They are switching from a bullish mindset to a defensive mindset, pulling money out of the weaker companies still trying to prove they can generate strong profit growth, and putting more into the ones that are doing just that.

Investors aren't just placing bets on the likely winners, they are also helping to arm them with more capital and resources. When a tech company that pays workers in options or restricted stock units sees its stock price rally, it is better positioned to retain and hire the best talent in the industry. Conversely, a company with a sinking stock price could see a drain of their top talent.

A report this week from Bernstein Research, cited in Barron's, underscored how stock performance affects the retention of engineers. Alphabet's engineers are likely to leave when its stock is languishing, and vice versa. Yahoo's talent pool has deteriorated in recent months as its stock declined.

The report concluded, “It is very hard to become a giant... and companies that do not become one of these large scale players (which some might call “platform companies”)... will be always subject to the competitive threat from the giants.”

A similar advantage exists in M&A as well. If Facebook, say, sees its stock appreciate while smaller public and private tech companies find their valuations diminishing, its stock will go that much further when used as a currency for acquisitions.

Most of the larger, successful tech companies also have tens of billions of dollars in cash, and are generating more each quarter. Much of this cash is overseas, to be sure, but if the economy slows you can count on many of them lobbying, as they did during the last recession, for a generous tax break to bring their overseas cash back to their US-based accounts. Some of that cash could go to fuel more acquisitions.

And as we've seen this past month, it's not just the public companies that are having investors divide them into the strong and the weak, it's the private ones as well. Uber, Xiaomi and Airbnb may have plenty of cash to carry them through a slowdown, but others aren't so lucky.

Square's IPO looks to price $2 billion below its last private round. Blackrock, which invested in a round that valued Dropbox at $10 billion in 2014, cut its estimate of Dropbox's per-share valuation by 24 percent last month. Fidelity marked down its investment in Snapchat by a similar amount this week. Fortune discovered others, like Dataminr and AppNexus, that Fidelity marked down, as well as non-tech companies like Blue Bottle Coffee.

Smaller private companies that want to remain independent may have no choice but try to go public, especially if their venture backers want an exit sooner rather than later. But in down times, investors lose interest in companies that don't have a proven record of profits. Atlassian, which filed for an IPO Monday, should have no problem on that count. Square, which is still losing money, will be an important test case for other IPO candidates in the red.

If IPO investors continue to grow choosier, an acquisition will be the be best remaining option for many companies needing new capital. But by then, the M&A market will be a buyer's market, and companies are likely to be selective about targeting acquisitions that strengthen their own offerings. IAC, for example, sees Angie's List as a strong fit with its HomeAdvisor business.

Angie's List is profitable and far from a failure. But that's my point. Until recently, you had to be a failure to be in trouble. Now, it's enough for you to be weak. Angie's List has had four years as a public company to improve on its subscription model but it never caught on at scale. Yelp's reviews were free and had a deeper database of reviews.

Investors aren't close to panicking, but they are moving away from faith-based investing. They want to see profits, and more than that, they want to see vitality: growth, yes, but a compelling story of why it will continue. The companies that can deliver may face some setbacks in a downturn, but they are positioned to grow stronger over time.

Those lacking vitality, however, might find themselves facing flow charts of choices like this: If there's no more venture money, go public. If there's no IPO demand, get bought. If there's no acquirer interested, start cutting costs and hold on. As things are looking now, this is turning into a market that doesn't favor the weak.


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