I’ve been buying and shorting tech stocks since floppy disks were floppy. In all that time, I’ve always been amazed at the steep premium investors are willing to pay for anything even remotely tied to the sector. In the 1990s, all you had to do to command a massive valuation was slap a “.com” onto your name. That is not an exaggeration. In 1998, I shorted a company called 7th Level that was two weeks away from running out of cash. It changed its name to 7th Level.com and its stock jumped from $2 to the mid-teens in a single day. These days, private companies in the tech space–so-called “unicorns”–are all the rage. Few, if any of these billion dollar babies have earned a cent. Commonsense says most of them never will. And yet, VC firms and other private backers are perfectly willing to throw more cash at them in round after round of financing.
Investors justify these lofty valuations with fanciful TAM guesstimates and accelerating revenue projections. This is nothing new. It’s the same wishful thinking that drives all manias, tech or otherwise. But what seems different to me about the current tech boom is just how un-technological most of the players are. Uber lets you hail someone else’s car, AirBnB lets you sleep in someone else’s bed, and Snapchat lets teenagers erase naughty messages before their parents see them. It’s hard to see any significant technological moats around those ideas.
We’re in the middle of a buyout frenzy for the ages. Every day brings news of another mega deal, either real or imagined. On Sunday, Cigna rebuffed Anthem’s $47 billion offer. This failure-to-merge is a rare exception. Many large and established companies have successfully gobbled up other large and established companies in recent weeks, especially in the tech space. In March, NXP Semiconductor bought Austin-based Freescale for almost $12 billion. Singapore’s Avago paid a whopping $37 billion for Broadcom a few months later, and Intel recently completed its $16.7 billion acquisition of Altera.
This merger mania is partly a product of record low interest rates around the globe. Profitable, cash rich firms can sell bonds with vanishingly low interest rates, making major acquisitions relatively easy (and cheap) to finance. Furthermore, the US tax code encourages firms to borrow money, as interest costs are treated as a deductible business expense. Add it all up and it’s little wonder that every company out there is starting to seem like a viable takeover candidate.
Unless you’ve been living under a rock or on a commune somewhere, you know the big news in the markets over the past few weeks has been the plummeting price of oil. With domestic production at record levels thanks to the fracking revolution and OPEC stubbornly refusing to cut production, oil is getting cheaper and cheaper. Investors have predictably responded by selling off energy company stocks in a big way. That makes sense. Lower prices mean lower profits and, especially for smaller producers, possible bankruptcy.
But there are two related stories to the drop in oil that don’t make sense, in my opinion–and they could signal potential opportunities on the long and short side.
This past week’s sell-off might signal the beginning of the end to several recent manias, especially in the biotech, social media, and cloud computing sectors. But, to my amazement, one mania seems to be going strong. As just about every stock in the markets got eaten for lunch on Friday, a new restaurant company called Zoe’s Kitchen debuted—and jumped 65 percent.
I know a fair amount about the restaurant business, both the good and bad of it. I am lucky enough to own a restaurant that’s doing quite well (knock wood). A few years back, I owned another restaurant that didn’t do well. Like most eateries, it failed in less than three years. As a money manager, I’ve been studying the industry and investing in restaurant companies for thirty years, and I’ve never seen anything like this “fast casual” craze.
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.