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Frothy Valuations for Facebook and Groupon Sparking Worries of New Dot-Com Bubble

Companies / Tech Stocks Apr 25, 2011 - 12:07 PM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleDavid Zeiler writes: With valuations of Web-based companies like Facebook Inc. and Groupon Inc. zooming ever higher, questions have been raised over what these companies are truly worth and whether we're seeing the early stages of a new dot-com bubble.

"The markets are showing signs of speculative froth," Martin Sorrell, chief executive officer of marketing giant WPP PLC (Nasdaq ADR: WPPGY), told the trade journal Information Age in a recent interview.


And the social media companies seem to be whipping up the bulk of that froth.

Filing for Dollars
Two weeks ago, The Wall Street Journal reported that social e-commerce site Groupon is expected to choose Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) as underwriters for an initial public offering (IPO) that could value the company at $15 billion to $20 billion.

Earlier this year, Goldman assembled a $500 million deal to allow more private investors to own a piece of Facebook. That deal propelled the valuation of the social-networking icon to a stratospheric $50 billion. Facebook is expected to go public in 2012.

Although Facebook and Groupon have attracted the most attention, private-investor interest in tech companies, especially Web-based ones, is skyrocketing. And that escalating interest is driving valuations higher.

"Investors are swarming for the next cool thing," Paul Graham, head of venture capital firm Y Combinator, told The Journal.

Money is pouring into young tech firms - even those seemingly years away from an IPO - from three different sources. Capital is flowing in from:

•Heavy investments by venture capital firms.
•Special funds set up by financial giants like Goldman.
•And "secondary-market" trading of private shares held by current and former employees of a company.

Twitter Inc., for example, has said it has no desire to go public, or even to raise more cash, but frenzied private investment activity has spiked its valuation to $7.7 billion.

Still, many Web-based companies are eager to go public. The list of IPO filings has grown rapidly this year.

LinkedIn, a social networking site for professionals, in January filed for an IPO that could bring in $175 million. Streaming music favorite Pandora Media Inc. filed for an IPO on Feb. 11 in the hope of raising about $100 million. Popular real estate site Zillow Inc. filed its S-1 just last week, looking to raise $58.1 million.

Zynga Game Network Inc. hasn't yet filed for an IPO, but is expected to go public in 2012. The purveyor of such Facebook staples as FarmVille and CityVille has been talking to T. Rowe Price Group Inc. (Nasdaq: TROW) and Fidelity Investments about $500 million in financing, which would put its valuation at $10 billion.

Not Your Daddy's Dot-Com Bubble
The amount of money being tossed around has reminded some of the heady days of the late 1990s when many dot-com companies with no profits and poor prospects went public, soared in value, and then crashed. Many of those companies went bankrupt within months of their IPOs.

Memories of that dot-com bubble kept investors away from new Web-based businesses for much of the past decade. But the runaway popularity of companies like Facebook, Twitter and Groupon has lured them back.

Several factors set the current-day obsession with Web firms apart from the dot-com bust of a decade ago.

First, almost every object of investor affection today is making money, and several actually have the potential to make a lot of money.

Pandora, for example, made $819,000 on revenue of $78 million in the first nine months of 2010. In the same period, Facebook made $355 million on revenue of $1.2 billion, with analysts estimating revenue for all of at $2 billion. LinkedIn showed a profit of $1.8 million on revenue of $161.4 million.

"Most of the companies that are in registration, or [that] are starting the process, are companies that have really good prospects," Mark Baudler, a partner at Silicon Valley law firm Wilson Sonsini Goodrich & Rosati, told Marketwatch. "It's not fly-by-night companies hoping beyond hope that there is a way to get out the door. The pipeline is so good that the best companies are at the front of the line."

Second, the number of Web-based companies contemplating IPOs is far smaller now than it was during the bubble. There were 48 tech IPOs last year, compared with 308 tech IPOs in 1999, according to Renaissance Capital.

"In those days, you had tiny, little companies going public that hardly had a business plan," Stefan Nagel, associate finance professor at Stanford University, told The New York Times. "And now you're talking about only a few companies - companies that are already global and with revenue."

Fundamental Questions
But even if many of the new tech wunderkinds have solid businesses, are they really worth billions now?

"You have a bubble when valuations aren't justified by the underlying fundamentals," Wharton management professorDavid Hsu told Knowledge@Wharton. "We still have no filing documents for most of these companies to see the experimentation with monetization that's going on, or the proof that [their business models] work." Until then, he says, "you have to look at issues like barriers to entry, the value of first-mover advantage [and] the importance of reputation, and consider whether these factors justify these superstar valuations."

Assuming most of the high valuations are justified, the real downside could be that most of the companies' potential will already be factored into the issue price.

"Investors can get starry-eyed, but they are going to need to see aftermarket returns," Kathy Smith, principal at Renaissance Capital, told Marketwatch. "That means when the IPOs come out they have to come at enough of a discount for stocks to rise in the aftermarket."

The true high-risk plays in the Web segment could well be the crowd of copycat companies that follow.

"I worry that investors think every social company will be as good as Facebook," Roger McNamee, a managing director of Elevation Partners and an investor in Facebook, told The New York Times. "You have an attractive set of companies right now, but it would be surprising if the next wave of social companies had as much impact as the first."

Mike Maples, managing partner of the venture capital firm Floodgate and an early investor in Twitter and Digg, agreed that any danger of a tech bubble would come from copycats, not the established names.

"In a given year there are maybe 10 or 15 companies that are truly valuable, and then everyone crowds around the soccer ball - those companies end up having their valuations get away from them," Maples told Venture Beat.

Source : http://moneymorning.com/2011/04/25...

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