Recently, we wrote about the four most dangerous words in investing – ‘this time it’s different’. As words to invest by, they’re hard to beat.
Sometimes, it also pays to remember a similar, though older version of that same sentiment. The philosopher and writer George Santayana, in 1905, wrote:
“Those who cannot remember the past are condemned to repeat it”
In our short history, fool.com.au has written a number of times about what we see as a possible house price bubble here in Australia, but this time I want to warn of looming problem on the horizon – Bubble 2.0
Lessons From The Past
If you were unlucky enough to be invested in the technology sector around the turn of the century, you’ll remember the dot.com crash with an almost primal reaction. Many billions were lost as internet-based businesses went to the wall, and others became mere shells of their former selves.
One of the most spectacular – and infamous – dot.com crash victims in the United States was Pets.com. Pets.com raised millions of dollars of equity. They had a sock puppet as its mascot and advertising gimmick.
Summing up the situation beautifully, in 2000, Jeff Fischer wrote the following on our sister site, fool.com:
“Pets.com raised millions with nary a sustainable advantage to its name […] and the venture capitalists knew that most of the money would be blown on marketing. Then, Pets.com was able to go public without a penny of value creation, let alone meaningful experience, under its belt.”
‘Eyeballs’ were all the rage. It didn’t matter how sustainable the business model was, or how high the actual revenue or profit figures were. What mattered was how many people your website was attracting, or simply might attract at some point. Share prices disconnected from reality, and from gravity, and became little more than the sum total of the hopes and dreams of an excited crowd.
Now true enough, companies like Amazon and eBay stand as testament to the ability of some companies to withstand the market carnage all around them, but they are the exception that proves the rule.
Survival is Not Enough
Even companies that did survive had their share prices slashed. Here in Australia, Telstra (ASX: TLS) was arguably our most widely held example. Trading as high as $9.20 in late 1999, Telstra was still primarily a telecommunications company, but the internet future was bright and Telstra had BigPond. Besides, anything in the technology space – no matter how broadly defined – was sure to boom.
At last count, the Telstra share price is now languishing at around $3.04, down two-thirds from its peak, and businesses such as One.Tel and Sausage Software have been consigned largely to business history (other than the occasional lingering court case).
Party Like It’s 1999?
Just over a decade later, we have seen some astronomical prices being bandied about for the next generation of internet leaders:
The owners of group-buying site Groupon were reportedly offered between USD$5-$6 billion ($4.69-$5.63 billion) by Google for their business – and they turned it down!
Facebook-for-business site LinkedIn listed on the US Nasdaq exchange last week. Originally offered at an IPO price of between USD$32 and $35, the company increased the offering price to USD$45 even before public trading started. Not to be outdone, buyers then pushed the price as high as USD$122, before closing the week at $93.09, valuing the company at USD$8.8 billion ($8.25 billion).
Combining social networking and China is an even more potent combination, and US-listed Renren is a case in point. I can’t put it better than Rick Aristotle Munarriz did:
“Two words were enough to set the Renren hype machine in motion: China’s Facebook.
A lack of profitability, its gargantuan proposed market cap, and the dicey nature of a social platform in China didn’t get in the way of a smoking hot IPO. The American depository shares, which were originally pegged to be priced between $9 and $11 apiece, were eventually sold at $14.”
Lastly, the company that reignited the white-hot interest in internet stocks, Facebook, has been estimated to be valued at between USD$50 billion and USD$100 billion, according to this report (subscription required) in The Wall Street Journal.
Now I don’t know whether any or all of these companies will justify these lofty prices, but the bar has been set very, very high for investors who are looking for a superior return from here.
Winners and Losers
What I can confidently forecast is how this will play out. Maybe one or more of the above will become the Amazon or eBay of Web 2.0. But just as certainly, the events of the past 6 months will excite investors – and I use the term advisedly – enticing them to pay higher and higher multiples for businesses of progressively lower quality. For every Amazon, there will be a Pets.com.
Just as surely, Australian-based businesses with similar or derivative models will follow. Some will succeed, some will fail.
The bubble hasn’t fully formed yet, but it’s inflating.
Eyeballs were – and are – vitally important, especially for any advertising- or subscription-supported business. Of infinitely greater importance, however, is the ability of each business to turn those eyeballs (or members) into cold hard cash. The extent to which that business model is sustainable will alone determine the long-term success of these companies.
Even if the businesses survive, investors have an additional hurdle to jump. Company survival alone isn’t enough. Telstra made it through the dot.com bubble in one piece, but some investors are still down 66% on their purchase price. As the bubble inflates, expectations will rise, and multiples will grow and grow. Only the combination of the right company and an appropriate price will ensure success.
Many will learn that lesson again when Bubble 2.0 bursts.