June 7 2011
by Thanasis Delistathis

Pinch me: is it 1999?

I attended TechCrunch Disrupt a couple of weeks ago and the scene was abuzz with talk of a new tech bubble following the LinkedIn IPO, on the heels of privately traded Facebook shares at exorbitant valuations.  The Groupon IPO filing last week helped reinforce the feeling that things are heating up. So, are we living through another tech bubble?  Quite an ironic question at a time when economists worry about the risk of a double dip recession in the general economy.  As Mossberg reports, you’d never know that if you attended his well known tech conference D9 last week.

I have been thinking about this for some time so I wanted to offer some thoughts.  To get a perspective on “economic bubble,”  I looked it up in Wikipedia.  An economic bubble generally refers to trading in assets with inflated values, above “intrinsic” values.  Not a new phenomenon.  And not one that will go away.  My favorite historical example is the Tulip Mania of the 1600s, when, at its peak, some single tulip bulbs were sold at 10 times the annual income of a skilled craftsman.

So to answer the question of whether we are living through a tech bubble we have to answer: when do we know that a price is inflated and what is a company’s intrinsic value?  I contend that we almost never really know, except in retrospect.  We all now think it was silly that tech companies were able to go public in 1999 with only $1MM in trailing revenues.  Nenvertheless, many people bought those stocks.  What were they thinking?  Was it just the herd mentality: some people made quick money with the first one so everyone jumped in?  Possibly.  A buyer usually makes that trade based on the expectation that the stock will go higher usually on the backs of dramatic revenue growth.  Taking momentum investors aside, I remember the talk in 1999 was that the world was dramatically changing, and the the internet would move dollars from old media to new media and that e-commerce would replace brick-and-mortar retailers. I think that is happening but it is taking much longer than people thought in 1999.

So is the situation now the same as 1999, just with different monikers: social graph instead of eyeballs?  There is a key difference: the companies looking to go public now have a history of operating as substantial companies.  They have proven that they can stand on their own. As an example, LinkedIn had $243MM in revenues last year and $15MM of net income.  I think it is the result of a general maturation in online usage and the businesses that serve it.  More people are online, spend more time on the internet, using it for more things.  As a result we are seeing an accelerating trend in advertising, subscription and e-commerce dollars moving online.  The evidence for this are the businesses that are hurting (or dying): newspapers and magazines, music retailers, yellowpage directories, book retailers, local TV stations, etc.  Perhaps it is time for the Mary Meeker gap (the difference in ad dollars spent online now and what would be spent if dollars were allocated proportionately with time spent in each medium) to begin closing.  If each hour spent on facebook was worth the same as an hour spent watching TV, facebook would be one of the largest (if not the largest) media company in the world in terms of revenues.  Perhaps this is why some investors are willing to value Facebook between $50-70BN in private transactions.

All that said, there are signs that things are heating up, especially in consumer internet, especially in Silicon Valley and New York.  The volume of new businesses is increasing, the focus of each business is getting more and more narrow.  That is partly due to the availability of easy angel dollars driven by many small acquisitions by larger companies.  It is also partly due to the fact that you only need $100-250K to start and launch an online company these days.  But even in this regard it feels different that 1999.  Even though most will surely fail, the dollars flowing in are not out of proportion to the market opportunity so that from a portfolio standpoint the returns are attractive.

But the question still stands: is the price paid for these businesses close to their intrinsic value?  As of this morning, LinkedIn was valued at about $7.6BN, or about 19 times current revenue run rate, or close to 2200 times last 4 quarter earnings.  It certainly seems inflated relative to the norms for companies growing at about 25% per year (usually having a P/E of 25).  However, LinkedIn is growing at a much faster pace, almost doubling every year.  If LinkedIn becomes the way business people manage their network of contacts on a global basis LinkedIn could be raking revenues in the billions.  When Google went public it had a similar Price to Revenues ratio.  Many people thought it was inflated.  Yet, Google is now worth 5 times more that it was in mid-2004, and it has a PE ratio of 20!!


June 8 2011
by Vasudev (Vas) Bhandarkar

Great points, Thanasis!

Not withstanding the euphoria surrounding the handful of IPOs around Tech stocks (LI, Groupon, FB, etc) — largely because there’s a shortage of them, the overall performance of the Tech industry now, ca 2010 is much better than the bubble era ca 2000.

For instance, according to Bloomberg, profits for tech companies in the S&P500 are at $135.6B in 2010, compared to $72.9B when the S&P reached an all-time high. Per-share earnings will rise 24% for tech compared to 17% for the rest of the companies in the index. Also, using other measures, tech stocks overall appear to be undervalued. Eg, Price to EBITDA today is 9.3 compared to an overall average of 14.5 since 1992 and much below the 38.3 P/Ebitda ratio of March 2000.

On average Tech stocks are cheaper compared to the rest of the market.

(There are outliers by (poor) stock performance too…eg Microsoft has not done well despite returning substantial dividends and revenue and earnings growth)

June 8 2011
by Thanasis Delistathis

Vas, These are some great stats. Thanks for sharing.

June 12 2011
by Dave Payne

Like many entrepreneurs this question has been rattling around in my head as well. I don’t have a strong stance either way (bubble vs healthy enthusiasm), but the valuations of low-revenue companies does seem bubble-like. It seems like every day there’s a new TechCrunch article on another iPhone app that generates 1 million downloads per week that just raised a Series A at a crazy valuation. This seems very much like the late-90s eyeball game. It’s easy for viral growth of neat apps…but how will these apps become big businesses?

What appears different this time is that those types of startups are only part of the eco-system. The rest are companies with high valuations based on traditional multiples, but they are healthy, growing businesses. LinkedIn & Groupon would be two of these. Sure…valuations seem nuts, but less nuts when you look at product opportunities and growth.

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