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.]