I hope that the title of the article didn’t scare you. Yet I felt compelled to share with you the same confusion many in the social media world are currently going through with regard to company valuations.
I got to the article “4 Reasons Today’s Tech Scene Differs from the ’90s Bubble” through the article “Buffett Declares Social Media Valuations Overpriced“, in which Buffett, in eerily similar fashion to the Tech Bubble 1.0, claims “it’s extremely difficult to value social networking site companies” and that “some will be huge winners, which will make up for the rest.”
As a student of investor sentiment I love to point out when investors’ hearts jump far ahead of their minds. One of my favorite books of all-time is “Extraordinary Popular Delusions and The Madness of Crowds” in which Charles McKay journeys through the greatest examples of herd-mentality people’s money has been subject to.
I’ve become quite keen of bubbles. Both finding them and pointing out false ones. Tops are more fun than bottoms, simply because bubbles are so much more entertaining.
It’s a funny thing money, because it’s something we work our whole lives for and yet it can drive us completely insane. We gamble when we have everything to lose and we shy away from the greatest of opportunities.
Back to the article.
If you insist that Facebook is worth $85 Billion today you deserve to be made fun of. Let’s begin.
Alexander Hotz is a freelance multimedia journalist and public radio junkie based in New York City. Currently he teaches digital media at Columbia University’s Graduate School of Journalism.
So now we have a case of Buffett vs Hotz. Who do YOU think is going to win? That’s right. The 80 year old investor or some young “public radio junkie”. Sorry, Alex but my money’s on Buffett.
We currently have the following valuations:
Quora $1 Billion
Twitter $10 Billion
Facebook $85 Billion
Alex mentions 4 reasons why “this time is different”.
1. Startup Costs
“[In the 1990s], when you started a company, more money was pumped into office space, servers and equipment,” said Mimeo.com Founder Jeff Stewart. “Today, when you build a company, you don’t own a server — you might even have mobile office.” With so much infrastructure now in the cloud, entrepreneurs can focus more on the product than they could in the past. For their part, investors don’t need to invest as much, so at least in comparison to the 1990s, oftentimes the risk is less. Bottom line — it costs less to start a company today.
There are 3 immediate issues I have with that paragraph.
a. It’s not true. Yes infrastructure costs have lowered significantly yet other costs and other distractions have taken its place. Today, marketing, lead generation, code writing and technical expertise have taken the front seat – aspects just as time consuming as taking out the trash or actually selling product.
b. This doesn’t help us. If startup costs have dropped that means that the incentive for other competitors to compete has risen. What stops some potential college drop-out from spending his night writing better code than your oh-so-genius team?
c. This isn’t a reason. So let us assume that you do have a patent-pending for your state-of-the-art tech-savvy game-changing app. How do you make money? If there’s no money, there’s no valuation. Period. I’ll write that again because it will recur throughout this article. If there’s no money, there’s no valuation.
2. Public vs Private
In the 1990s, tech companies raced to secure a lucrative IPO. When the bubble burst in March 2000, those who got burned weren’t just angel investors and VCs, they were less experienced investors who had jumped on the tech bandwagon.
Today, younger companies aren’t in a rush to go public. Think Facebook’s “special purpose vehicle” with Goldman Sachs. What’s more, today’s public tech companies are market stalwarts. “You can’t call Amazon or Google or Apple overvalued,” said OrganizedWisdom CEO Steve Krein. “[In the 1990s] you could have called DoubleClick, Amazon and Yahoo overvalued.”
Krein agrees with Fred Wilson that the startup world has some “frothiness” or excess capital, but comparisons to the 1990s don’t take into account where the investors are coming from.
Firstly, investors are investors. And history has proven the astute “experienced” investors to be the ones who are often the most foolish ones. You may insist that small investors won’t get burned this time and, I agree, that’s a good thing. But that doesn’t in any way validate the stupidity of the affluent who we know spend millions of dollars on other stupid stuff like art, CDOs and credit default swaps.
I have no doubt that if the small guy could get in on this mayhem, he’d buy Facebook faster than he bought Enron and Pets.com 12 years ago.
Then he mentions Google, Apple and Co., which makes my head spin. Of course Google wasn’t overvalued in 1999. It didn’t exist! So while investors were piling into Yahoo and Juno their ultimate rival wasn’t even a prototype!
The second mistake is a bit more complex. You can’t use the survivor to prove the challenge. You can’t take the 1997 Bulls and claim that the Michael Jordan draft pick was a home run. Apple has come a long way since 1999. Jobs had just joined the company again after 10 years of struggling profits and a stagnant share-price.
3. Hubris
A less tangible difference between the 1990s and today’s startups is the dynamic between the up-and-comers and the established titans. “[In the 1990s] there was a sense of confidence that the new companies would knock off the old companies,” said MeetMoi.com CEO Andrew Weinreich. “Imagine Time Warner, the most venerable of media companies, literally giving away half of itself to an Internet startup AOL. If you were in a startup, you really thought that you would knock off existing players.” Today, the big players are the survivors of the dot com era.
I have to give it to him. He had the substance of a real argument until the last line. Which survivors are we referring to? When people talk about Google being taken over by Facebook, what does that say about hubris?
Finally, since when does hubris a necessity for a valuation bubble. All we’re saying is that investor aren’t discounting anything for the future. Webster’s defines a “Bubble” as “a state of booming economic activity (as in a stock market) that often ends in a sudden collapse”.
When VCs are throwing (literally) money at these new tech startups there is a definite chance of a sudden collapse in economics activity, at least in Silicon Valley.
4. The Bubble Isn’t a Profitable Joke
In 2000, entrepreneur Philip Kaplan created the satirical website FuckedCompany.com (a take on Fast Company), lampooning the absurdities of the startup world. “When you have a profitable business built around making fun of the bubble, that’s an indicator,” said Stewart. The site made some serious money off the woes of the floundering dot com world. Today, while satirical blogs and social accounts are plentiful, none of them come close to the profitability of lampooning the last bubble.
Do we really need jokes to prove investor insanity? Mind you, every child knows that (bubblegum) bubbles take time to grow, but only an instant to pop. Investors should bear in mind the same. That one day there will be a joke, the next it won’t be so funny.
So is there a bubble?
No.
Guess you weren’t expecting that answer. The fact is that if investors are going this crazy now, it’s due to continue for some time. True, there are no jokes, there are no naysayers (and thus stark advocates) and it’s not the hottest topic on CNBC. Most of all, there aren’t enough people claiming it’s a bubble (yes, a bubble needs a conscience). Not yet at least. But once the IPOs start rolling out and the small investors do get wind of what’s going on, it will end, and badly.
Wait I say.
Wait for the “Facebook taking over Apple” articles.
Wait for the momentum, when volatility increases.
Wait for the young and inexperienced investors to sit on the set of CNBC and tout the reasons for their madness.
Wait until earnings become paramount, while balance sheet quality, cash flow from operations are ignored.
Wait until these “low cost” startups begin to run low on the mountains of cash they acquired.
Wait for when the accounting seems compromised, when large amounts of earnings stem from accruals rather than cash flow from operations.
Wait for the article that say “This time is different”, “P/E ratio’s don’t matter” and “If you don’t invest now you’ll die a broke old man”.
When Buffett said that he “didn’t get tech,” he didn’t mean that he didn’t understand technology; he just couldn’t understand how technology companies would earn returns on equity justifying the capital employed on a sustainable basis.
Tags: Apple, bubble, Buffett, CNBC, Facebook, funding, google, Investing, investors, price, share, social media, startup, stock, tech, Technology, valuation, VC, venture capital
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