On Seeking Alpha, I had been one of the most critical of the rising expectations and valuation multiples for many high-growth tech companies. Early on, in May 2012, I believed that the froth was limited to small micro-bubbles in the social media, Internet, SaaS, and virtualization industries. However, by December 2013, as valuation multiples expanded, the IPO window reopened, and value opportunities diminished, my skepticism increased. Following a February 20, 2013 article, I took a lot of criticism (both on SA and off) for vocally calling a "bubble" and warning that "investors should avoid tech companies with high valuation multiples."
Data tweeted by tech VC Marc Andreessen on April 14, indicates that of 7 top [high-growth] consumer tech companies, the median company was 37.4% off its (recent) high while the median of 4 top [high-growth] enterprise companies was 42.0% off its (recent) high.
Where Do We Stand
While many of the most richly-valued tech companies have been hard hit, the focus on recent performance is not productive. What matters is not how far the bubble darlings have fallen but whether they now represent a compelling investment opportunity. Let's look at a couple of the names that Andreessen cited (as of ~3PM on 4/15/2014) in depth:
Yelp (NYSE:YELP) is at $62.17 a share (down from over $100), implying a current market cap of $4.4B, an EV/Revenue ratio of >17x and a P/B ratio of ~9x. With an enterprise value of ~$4B, Yelp is already valued at roughly 1/3 the level as each of the two leading yellow page companies [Verizon (NYSE:VZ) Yellow Page/Idearc and RH Donnelley] were in their heyday. At the time, the yellow page oligopoly was the "go-to" place for local advertising, and each company had an enormous local sales force, billions of dollars in revenue, and substantial EBITDA relative to its valuation.
In contrast, Yelp faces direct competition from Google (NASDAQ:GOOG), (NASDAQ:GOOGL), and is partially reliant on partnerships with Bing, Apple (NASDAQ:AAPL), etc. for distribution. Equally important is that many of the company's prospects/customers do not like the service, because it often hosts reviews that are critical of those prospects/customers. For years, mainstream coverage of Yelp has sometimes characterized its sales efforts (whether deserved or not) as "extortion" or a "shakedown racket."
Though the company has a 71% trailing YoY revenue growth rate, it is off a small base during a period of economic recovery. As people learned in 2008-2009, the small business advertising market can be a leading economic indicator (as failing SMBs obviously stop advertising, and it is one of the first places that surviving SMBs cut back during tough times). In addition, steady-state margins are TBD as the company had negative operating income and less than $10M of operating cash flow in the most recent quarter. Does Yelp sound like a company that is worth 17x revenue, 9x book?
B2B SaaS company Splunk (NASDAQ:SPLK) remains one of the biggest head-scratchers. With a share price of $64.31 (down from over $106), the company has a market cap of $7.6B, an EV/Revenue ratio of >19x, and is EBITDA negative (though it did have ~$34M of operating cash flow in the quarter ending in December 2013)--with a P/B ratio of 8.95x. The company is expected to grow revenue 34% this year, according to Yahoo Finance. Though Splunk is often lumped in with hot "big-data" or "analytics" companies, it is important to understand what the company actually does. Though they recently released a (very interesting) Hadoop analytics suite called HUNK, that software is relatively new to the market. It is believed that most of their $302.6M in revenue for the year ended in January 2014 is related to their log-analysis software. With server sales revenue already slowing in Q4 2013 (driven by weakness at the high end), according to IDC, after a huge multi-year datacenter construction and server purchasing boom, it is unclear what the long-term outlook is for the market that supports Splunk's core log analysis offering.
Both Yelp and Splunk are innovative and interesting companies. However, even after substantial declines in share prices, their valuations remain difficult to justify. The same is true of other hard-hit growth/momentum names, like Workday (NYSE:WDAY) ($77.91/share, EV/Revenue >25x), Pandora (NYSE:P) ($26.20/share, EV/Revenue of >7x, and persistent margin challenges from high variable music royalties), and Netflix (NASDAQ:NFLX) ($326.27/share, EV/Revenue of 4.3x, and margin pressure from high content licensing/production and streaming costs).
New Opportunities for Bargain Hunters
The most interesting outcome of the recent decline in stock prices is that, while the richly-valued tech companies were the most affected, many other companies also suffered significant declines. After lamenting a dearth of value opportunities at the end of last year, I am starting to find interesting companies again. In future articles, I will focus on some positive value stories; it's been too much "sky is falling" doom-and-gloom lately.
Disclosure: I am long GOOG, GOOGL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: NOTE: The disclosure did not initially mention Google because it was not tagged or linked to from the original submission. Given that editors added the quote link to Google symbols, an updated disclosure is required.