could this be the beginning of the end of the social media mania?

I’m kicking myself for not following my instincts and shorting Yelp (YELP) before it announced utterly rancid earnings last Thursday. For years, the only thing that has mystified me more than Yelp’s business model has been its enduring popularity with Wall Street. As I type, I’m looking at a pile of recent analyst reports with absurd price targets for the company. I like to save these kinds of laughably optimistic reports. It’s a hobby of mine. I’ve still got a glowing buy recommendation for Enron dated only days before the energy behemoth imploded.

For all my doubts about Yelp and other social media stocks, there’s a good reason I have not shorted any of them up to now. It’s just too risky to bet against companies in the midst of a secular mania–and make no mistake, that is exactly what has lifted Yelp, Twitter, LinkedIn and their ilk to stupidly large valuations that they will almost certainly never live up to.

Even after melting down post-earnings, Yelp is still worth $3 billion, or 42x trailing 12 month ebitda. If revenue growth slows further, its stock could easily slide right along with it–and, if that occurs, it will probably go down a hell of a lot faster than it went up. Remember the old saying: “stocks eat like birds but crap like bears.” That’s what happened when the first dotcom bubble burst. The mania finally waned and earnings disappointments were followed by one major selloff after another. Last week’s putrid results from Yelp, Twitter and LinkedIn could signal the start of Dotcom 2.0’s unwinding–or not. The Fed is still unconscionably dragging its feet on lifting interest rates, meaning oceans of liquidity will continue to slosh through the markets, so I have no idea when exactly this insanity will end–only that it will end at some point, and it will be very ugly when it does.

Incredibly, the current bubble in tech and social media stocks is actually relatively modest compared to the one in private companies. Some of these billion dollar unicorns, like Snapchat, are self-evidently preposterous. They have no revenues and almost no hope of ever producing significant profits. Others, like Uber, are bringing in sizable revenues and have undoubtedly disrupted their industries but their long-term profitability is anything but certain. Uber already competes with Lyft and numerous other smaller competitors. As Kevin “Mr. Wonderful” O’Leary pointed out on CNBC a few months ago, none these of these firms offer a unique service and the barriers to entry for the business are virtually nonexistent. That means competition will likely increase not decrease over time, which will force providers to continue to undercut each other and offer steep discounts. That’s not a formula for consistently high earnings, and it’s certainly not a formula that justifies multibillion-dollar valuations.

What I’m saying is not complicated. By any objective standard, there is a reasonable, if not strong likelihood that companies like Uber and Lyft will never earn back their investors’ money. A reputable source recently shared the details of an offering document from Lyft with me. According to this person, the document showed that Lyft lost an eight figure sum in 2014 and will lose a staggering nine figure sum in 2015. Despite these clear indications that the company’s business model could very well be a losing proposition, investors can’t stop themselves from writing its founders massive checks. When I heard this story, it reminded me of legendary cash bonfires from the first dotcom bubble like Webvan and Pets.com. Their faults were just as obvious, and yet very smart people flung millions upon millions into the flames. To my amazement, it’s happening again. Trust me. Just like the last time, it will not end well.

*Postscript: As I’ve written before, this bubble is not an accident. It’s the end result of seven years of zeroed-out interest rates. The one percent, those who own stocks, high-end homes, and investment partnerships have so much capital to deploy in this free money environment, they’re all too willing to risk big to win even bigger. Meanwhile, the bottom half of America’s workforce–those who rent and put their money in savings accounts and money market funds–have seen wage growth stagnate and job opportunities diminish. Why? Because American companies are afraid to build plants and hire here given the excessive 35 percent US corporate tax rate, our idiotic territorial tax code that “trues up” offshore profits when brought back to the US, and complex regulatory issues. In my opinion, we need to loosen regulations on our private sector, tighten them on Wall Street, and raise interest rates above inflation so ordinary Americans will be rewarded for saving money. Unfortunately, we’re doing the opposite. We’re constraining our private sector, punishing savers, and letting the financial sector run wild yet again. We shouldn’t be surprised at the results.

[note: this post originally appeared on my Yahoo! Finance contributor page.]


6 thoughts on “could this be the beginning of the end of the social media mania?

  1. Alex

    Scott,

    You wrote “there’s a good reason I have not shorted any of them up to now”….. does this mean you are starting to short social media now?

    Thanks,

    Alex

    Reply
  2. spencer

    what are your views now given the development they are looking to sell the company? (and the subsequent 30%+ move in two days)

    Reply
  3. Roy C

    Yelp’s announcement pertaining to a potential sale of the company has caused a spike in it’s valuation. The market assumes that (1) Yelp will find a buyer and (2) said buyer will be willing to pay a premium on the already expensive equity. These assumptions will be difficult to realize. It does provide an excellent example of the dangers inherent to shorting during a secular mania. Valuations, at Yelp’s level, are no more than the greater fool theory. Although, it seems highly unlikely a buyer would be willing to pay a premium for Yelp (especially given the poor earnings report just released), stranger things have happened. I wonder what P.T. Barnum would say?

    Reply
  4. wisdom8020

    Dear Scott,

    Thank You for your great book and blog.

    I also thought of shorting social media stocks but never went into action because 1) shorting is difficult and 2) there is a chance that some large firm would buy them for some “synergy.”

    Indeed, Yelp is in trouble. See a post by footnoted.com (http://www.footnoted.com/report/a-closer-look-at-yelps-10-k/)

    Still I would wait more until the stock literally starts collapsing (consecutive large price drops or increasing price drops).

    Reply
  5. paul armstrong

    Thanks Scott for the great book. I really enjoyed it and hopefully can continue to develop the ability to follow some of excellent investment lessons that you have put forward. I have always been an optimist and when i make an investment i never expect it to fail. You would think that after owning and operating over 20 businesses that have all failed…??? that i would have learned that FAILURE is more likely then SUCCESS in business! I always prided myself on never quitting too easily…but that’s something that i will have to think about seriously. It might make my life a lot easier!!!

    Reply
  6. Pingback: cash is king: two good bets in the gaming sector | the confessions of a contrarian investor

Leave a Reply

Your email address will not be published. Required fields are marked *