Silicon Valley Thinks You’re a Fool
Be careful, investors. It’s getting bubbly out there.
In a book published several years ago, a shrewd author (OK, me) laid out the stages of investment bubbles: a few solid years of impressive fundamental growth give way to highly ambitious projections and world-changing proclamations; a host of new entrants run onto the field, oblivious to profits or many of the other basics of running a business; individuals and naïve corporations start to get in on the action with bold, aggressive moves; and in the most dangerous stage, the phenomenon crosses over into popular culture—i.e. from CNBC to NBC.
Events and portents of recent weeks show that when it comes to technology, we may be headed into bubblicious territory.
The individual investor may be largely sitting this investment boom out, but people forget that big, established corporations often spur activity by splashing out big money for dubious companies. The dotcom bubble didn’t start to burst when Uncle Joe bought 10,000 shares of Pets.com. No, it reached its apotheosis in January 2000 when Time Warner agreed to be acquired for AOL’s stock in a merger valuing the combined entities at $350 billion. Fourteen years later, corporations are again splashing out big bucks for hot new tech toys.
In 2014, Facebook has become an avatar, promoter, and beneficiary of the social media-related bubble. Earlier this year, it paid $19 billion for WhatsApp, a revenue-less messaging application. Then last week, it kicked $2 billion for another revenue-less company, virtual reality tech firm Oculus Rift. Rather than content himself with saying he had bought a new bauble, or that he paid out of a tiny percentage of Facebook’s valuation for something he thought was cool, Zuckerberg couched the acquisition in the characteristically bold terms of a bubble-surfer. As he noted in a Facebook post, Oculus is a new platform, a new world even. “One day, we believe this kind of immersive, augmented reality will become a part of daily life for billions of people,” he said. (And if you believe that, I’ve got a bridge in Second Life I’d like to sell you.)
Bubbles rely in large part on the greater fool theory—companies and individuals buy trendy assets on the hopes they can sell them to trendy investors for even more. Facebook, in effect, already is selling the businesses it acquires to others. The company’s stock has more than tripled since September 2012, putting Facebook’s market capitalization at $160 billion. Now, unlike Oculus, WhatsApp, and many other companies, Facebook has both revenues and earnings. But investors are paying an extremely high premium for them—$101 for every dollar of earnings.
In bubbles, we typically see the rise of businesses that exist mainly for the purpose of marketing themselves and gaining customers—not for generating cash flow, or turning a profit. There are plenty of those around, and they’re getting big valuations. Box, the cloud-based storage company that recently filed for an initial public offering, had about $124 million in revenues in 2013, double its 2012 total. Not bad. But as the Wall Street Journal reported, it spent about $1.38 on marketing alone for each dollar in revenue, leading to a $186 million operating loss. What’s more, it is operating in a highly competitive field in which anybody willing to splash out a lot of money can build a competing business.
In bubbles, even—no, especially—companies that offer faddish products and services thrive. Last week, King Digital Entertainment, the maker of Candy Crush, went public in a splashy initial public offering. First priced at $22.50, King’s stock fell on the first day of trading—a rarity for IPOs and a potential sign of sobriety among investors. But consider this. Online games, and online gaming companies, have extremely short half-lives. Zynga rode its one big hit, Farmville, to IPO riches and then crashed as soon as the trend turned. In 2012, Zynga paid more than $202 million, to buy OMGPop, owner of the hit game Draw Something. A year later, when gamers had moved on, Zynga closed OMGPop. King has been granted a market capitalization of about $6 billion, even though it has essentially one product, and even though the company’s revenues are already starting to decline.
To me, however, television programming often makes for the best bubble tell. It takes a long time for the entertainment community to latch on to a hot new trend. And then it takes even more time to sell the concept, order up a pilot, shoot the series and get it on the schedule. By the time a show on a hot financial or investing topic hits the airwaves, the phenomenon is usually over. TV deals for zeitgeist-capturing programming get inked during the “meltup,” and tend to debut just before the pop. The summer and fall of 2000, for example, brought us The $treet, a drama from Darren Star about hot young twentysomethings doing cool stuff with money, (including a very young Bradley Cooper), as well as ++Bull, (Same topic but on TNT.) A recession and stock market followed soon thereafter. In September 2005, when real estate was in full-on bubble mode, ABC gave us Hot Properties, a sitcom about hot real estate agents in New York. (The cast included Sofia Vergara). It was cancelled after nine episodes, and housing prices peaked soon thereafter. The Fox Business Channel launched in October 2007, just in time for an epic meltdown in the markets.
HBO’s hot new zeitgeist-capturing sitcom about young people in a hot business sector debuts next Sunday. The title? Silicon Valley.