1999 redux?

As I write about in the book I’m finishing up (it’s due out late this year or early next year–stay tuned for more details!), I’ve lived through a number of asset bubbles, or manias, in my career. By far, the most maniacal of these manias–and the biggest one in the history of capitalism–was the dotcom craziness of the late-1990s. It was absolute bedlam, and its epicenter was down the road from me in Silicon Valley, so I had a front row seat.

The normal metrics for valuing companies went haywire during those days. Revenues didn’t matter. Earnings mattered even less (because they were usually nonexistent). When it came to pricing a dotcom stock, it was all about “eyeballs”–the number of people visiting a given website.

If that sounds familiar, it should. It’s the exact same way people are valuing the darlings of the latest online mania–social media.

Today, “users” are the new “eyeballs.” People constantly celebrate the rapid growth in users for companies like Facebook, Twitter, LinkedIn, and Yelp. Of course, more people using a company’s product is good. But there’s a fundamental mathematical principle that these new dotcom bulls have conveniently forgotten. Soul singer Billy Preston sang about it in the 1970s:

“Nothing from Nothing Leaves Nothing.”

The nothing in this case refers to the amount of money most of these businesses are making. You can have all the users in the world, but if they’re generating nothing revenue-wise, that’s exactly what your business is worth. Investors in companies like pets.com and iVillage learned this harsh fact of arithmetic fourteen years ago and I’m afraid social media backers will learn it again sometime in the near future. While Facebook and LinkedIn have started to post modest profits, Twitter and Yelp still make less than nothing. Their earnings are projected to turn positive this year, but like their already (kind of, sort of) profitable social media peers, their forward PE’s will–at best–be in the hundreds.

Of course, plenty of hot new companies have PE’s higher than your average American’s cholesterol levels. But in order to buy at those kind of elevated valuations, you have to convince yourself that a business can grow its earnings enough to bring its multiple to a reasonable level, and that’s where the enthusiasm for social media stocks starts to feels awfully maniacal.

Facebook is by far the strongest and most profitable company in the sector, and even it is a very iffy proposition. Sure, it might have a billion users, and it might be making some money in the short term mining their data and selling advertising to companies hoping to reach them, but there’s plenty of evidence that people are already using the site less, and that fewer young people are using it at all. Not only that, just because somebody has an account doesn’t mean they’re logging into it regularly, or staying long when they do. It’s hard for me to believe that wealthier and more educated people are spending a lot of time posting photos of their cats or taking “which celebrity are you?” quizzes. Those kinds of activities appeal to poorer, less educated demographics–not exactly the types advertisers are willing to pay big money to access. In other words, the growth that is driving this mother of all growth stocks could very well have already peaked.

Even more troubling, this current mania might be worse than the dotcom craze or the biotech stock boom in the late 1980s. At least in those days, some of the companies being hyped were producing innovative products. You can’t say the same for these new social media outfits. When you get down to it, they’re not offering anything particularly unique or proprietary. Facebook is basically MySpace 2.0. Twitter is a place for people to peck out their thoughts online–like every other blog platform out there. What’s to stop another trendy or well-capitalized competitor from taking their market share? Google+ hasn’t managed to make much of an impact, but consumer tastes are awfully finicky, especially in this space. When the novelty of a given platform wanes, those coveted users–like the “eyeballs” of the dotcom days–turn elsewhere in a hurry. Buyer beware!


One thought on “1999 redux?

  1. Pingback: silicon valley’s bubble is bursting | the confessions of a contrarian investor

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