It is a familiar feeling isn’t it? Investors rushing in to get stakes into the next Google (GOOG) or the next Microsoft (MSFT). It seems like these companies can only go up! Are they profitable? Absolutely and that is already more than what could be said for many of the dot com companies from the 2000 dot com bubble. Companies like Pets.com or Boo.com had attracted huge valuations despite a poor (at best) plan to profitability. It didn’t matter after all because if you didn’t buy today, someone else would and tomorrow’s price would be much more expensive.
In some ways, that is how it feels today. Google was deemed to be crazy by many to have offered $6 billion for Groupon just a few weeks ago. Never mind the fact that the company ended up refusing the offer and is now preparing an IPO at a rumored $15 billion valuation. Did that company just double its profit estimates in a matter of weeks? And how about LinkedIn which also doubed its valuation in just few weeks. Better buy now because getting in the game at the end of February will probably be much more expensive. Right?
Different type of crash?
Wall Street can sometimes be a bit on the dumb side but they usually do not make the exact same mistakes and this one is no exception, as there are significant differences between what is going on and the 2000 dot com bubble.
-Not public: While most of the companies that ended up crashing in 2000 were public ones, the current ones are usually not traded on stock exchanges but rather through private and exclusive brokers such as SecondMarket which let high net worth individuals and companies only get involved as the traded companies have not yet reached the level at which they would be publicly traded, would publish earnings and other documents to the S.E.C.
-Most of these companies are profitable: Companies like Facebook, LinkedIn and Groupon are making revenues and even earnings unlike most of the dot com failures
-Less transparency: Since these transactions are taking place off markets, a lot of deals are taking place behind curtains and it’s not quite clear who is buying & selling, and what prices
Buyers rushing in
When Goldman Sachs initially announced it would be able to offer its clients a stake in Facebook at a $50 billion valuation, it was flooded with orders from both wealthy individuals and investment companies. Companies like Digital Sky Technologies are being admired not for getting in at cheap valuations but simply because they have been able to get stakes in some of the more valuable dot come companies such as Facebook and Twitter and right now, getting stakes seems like the only important aspect. Who cares about the price being paid? It’s about getting a stake, no more, no less. There is limited supply as the float of these companies is very limited. Most of the shares being sold are owned by early employees who want to get cash instead of stakes in a company that can seemingly only go higher… does that remind you of a familiar story? Mark Cuban.
Compared to the companies that made headlines in the first dot com bubble, these companies are gold. Not only do they have solid business plans but they are actually already making profits which is already much more than the ones from the early 2000s. That being said, there has to be someone that looks at valuations. This blog has been more than happy to call Facebook the best investment opportunity out there but if the valuation keeps going up by 20% every few months, that opportunity will no longer exist. Was Groupon a good buy for Google at $6 billion? Absolutely. But investing at a $15 billion valuation a few weeks later seems exaggerated. Since these companies are mostly private, few public numbers exist which has been making investors buy the name rather than a good deal. Are some of them good deals? Absolutely. But why is everyone throwing money at these companies without even checking twice?
What to do?
It’s difficult to determine if there is truly a bubble and even more of a challenge to time the possible collapse (talk to any Open Table investor). But I would advise against blindly buying all of these big names.
Disclosure: No positions on any of these names