FACEBOOK does curious things to people. Most recently, it has caused frustrated investors unable to get a slice of its profits to look to other social networks for gratification.
When LinkedIn made its debut on the Nasdaq this month, within two days it was valued at $10.1bn (£6.2bn). In other words, a business that is unlikely to make a profit over the next 12 months gained an overwhelming price to sales ratio of 27, rarely seen since the heady days of 1999.
And last week, Twitter bought TweetDeck for a reported $40m, despite the fact it does not generate substantial revenue. On the surface, these eye watering numbers make little sense from an investment point of view, and the only justification I can give for these stunning valuations is that it is a peculiar type of wish fulfilment.
Every generation has a company that comes along and profoundly changes the way that people live and work. Facebook is that company. When Facebook goes public there will be a feeding frenzy that will occupy the markets, but in the meantime investors are falling head over heels for LinkedIn, Facebook’s less interesting older sibling. I’m tempted to liken the surge in the value of LinkedIn with the Rorschach inkblot test – the experiment where participants see what they want to see based on their personal experiences.
Investors want to see huge returns, and many will certainly make them, but I can’t help but see this as the start of the next internet bubble. The evidence, not just from the public markets, but in the prices people are paying as private angel investors, suggests that the market is considerably overheated.
This is because over the last decade we have seen a distinct shift in the way the internet is used. It has morphed from an information web service to a social one. Because tech is becoming more and more central to our lives, a lot more people can understand the potential opportunities and thus become over-optimistic about it. This bodes well for other social networking companies, as it opens the door to other smaller companies that need an influx of cash to grow and expand. It is a seller’s market and entrepreneurs can raise money at stunning valuations right now.
For instance, in the US, East and West Coast businesses have increased values and fundraising opportunities because there are so few startups and SMEs.
In the UK, however, there are far more startups, but not so much money – an angel’s dream because of the sheer number of good deals that are out there. This bubble is a reflection of the boom and bust mentality that the stock market periodically goes through, and shows that lessons haven’t been learned from the dot-com boom of the late 90s. But what we do know is that everything that goes up must come down. The question is, how long do we have before this bubble will burst? We need to see Facebook go public before we can begin to contemplate when it might. Thankfully, unlike the bubble in 1999, these are much more substantial businesses, making significant profits, and it will be more like a stumble back down than a catastrophic crash.
But the question here isn’t whether these companies are real, it’s whether the prices they are securing are justified.
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