Seventeen years ago, I had a front row seat for the nuttiest mania in stock market history. I vividly remember visiting now failed companies like Quokka Sports, Planet RX, Women.com, and Commerce One and listening to their managements confidently predict glowing futures. These firms, and many more, sold above 100x revenues–and they were far from the most overvalued stocks in the market. Other public dotcom companies had no revenues at all. Their stocks soared on nothing more than hopeful business models and lofty expectations of explosive growth.
I was in the ninth year of managing my hedge fund in 1999. It gained 8 percent that year, badly lagging the S&P’s 19 percent return and the Nasdaq’s staggering 85 percent (!) gain. In March of 2000, the Nasdaq hit an all-time high of 5132.52. Then, on March 20th, Barron’s magazine wrote a much publicized article that listed every dotcom by its cash, monthly cash burn, and the number of months before each company would run out of money if it did not raise additional capital. There were 207 companies on that list. A large number went broke. Some of those flameouts, like Pets.com, live on in infamy. The majority of them are only recalled by hardcore stock junkies, especially those who got burned by their implosion.
Remember Be Free, ZapMe!, SmarterKids.com, drkoop.com, and MotherNature.com? Most investors under the age of 35 almost certainly don’t—and that’s a problem, because what happened to those businesses could easily happen to many of the new tech sector darlings. Far more companies in today’s public and private markets will probably become tomorrow’s drkoop.com instead of the next Amazon or Microsoft. And as we saw so vividly in 2000, when the end comes, it comes quickly.
By the end of 2000 the Nasdaq was down 39 percent, the S&P 10 percent. My fund was up 27 percent, as I shorted a variety of former highfliers based on visits with management and my belief that even companies that seemed well-positioned to survive (like Amazon, Doubleclick, and FTD.com, to name a few) could drop 25-50 percent or more in the ongoing Nasdaq collapse. Two years later, when the dust finally cleared, the Nasdaq was off 80 percent from its peak of 5000. Eighty percent.
Today, the Nasdaq is north of 5000 again and technology stocks are again leading the market higher. Many argue that things are different this time, and that tech names are not as excessively valued as during the late-1990s mania. They may be right, but I suspect any market selloff could easily hammer the tech sector as badly it did when the last bubble popped.
Take Facebook. Its market capitalization is $350 billion, vs. $18 billion in 2015 revenues. While FB has done much right, many people seem to overlook some glaring weaknesses in its business model. In the end, it is a well-managed advertising company operating in a business with limited barriers to entry. Remember My Space and Friendster? Both gone. While Facebook users are fanatical (the average FB user spends almost one hour a day on the service), many ‘heavy’ Facebook users are often ill-educated and have low household incomes. Not exactly an advertiser’s dream. Meanwhile, upstart competitors like Snapchat are already grabbing marketshare and many young people increasingly think of Facebook like I used to think of syndicated old black-and-white television programs like Leave it to Beaver and The Honeymooners when I was growing up—as an outdated diversion. Instagram still seems to be popular, but I question its longevity, too, as well as its potential for long-term profitability.
Other tech and social media companies have rallied recently, and also are richly valued. Zillow trades at 9x 2015 revenues, Twitter 6x revenues, and Yelp at 5.5x revenues. None of these companies are buys. All could get cut in half in a meaningful market selloff. Like Facebook, they are essentially advertising companies. That means relatively low annual capital expenditures, but also lower barriers to entry than companies like Boeing, General Electric, Intel and even Microsoft. I started writing doubtful articles about Twitter’s future well over a year ago. Its stock was close to $50 then. Now, it’s below $20 and I still can’t see any earthly reason to buy the stock. For well over a year now, rumors have circulated about an imminent buyout. Now even Twitter insiders are openly admitting that they would consider being acquired—and yet no buyer has surfaced. It’s not hard to understand why. What’s hard to understand is why so many people believe that any company would pay more than $13 billion for a profitless business with poor management and flat-lining growth. That kind of magical thinking is the best argument that it isn’t “different this time.”
Compounding today’s valuation largesse, of course, is the number of still private companies with valuations above $1 billion. While new so-called “unicorns” aren’t being created as rapidly as they were in recent years, at last count there were still 133 of these behemoths out there. (By comparison, back in 2000, there was exactly one private firm valued above $1 billion.) If companies like Uber or its unicorn ilk ever do go public, any selloff in their stocks could drag the entire technology space lower, as well. But as valuations continue to swell and the prospect of profitability for most of these businesses continues to recede into the dim reaches of an imagined future, it’s increasingly hard to see how most of them can go public. Would stock investors really be willing to pay the cost it would take to exceed their gargantuan private market values? The answer to that question might end the debate over whether the current bubble matches or exceeds the craziness of the dotcom era.