A Different Kind of Tech Bubble; More Localized and Targeted

by: Lenny Grover

With some private social networking companies, like Facebook and Twitter, trading at valuations of more than twenty times their estimated annual revenues, a lot has been written about the possibility that we are in another tech bubble like that of the late 90s. In that bubble, a rising tide really did lift all boats, with technology companies of all types (hardware, software, Internet, B2B, B2C, etc.) trading at incredibly high multiples.

This time around, the "bubbly" valuations appear to be more localized. Looking at the SecondMarket Q4 2010 data around private company transactions, it appears that over 75% of the buy-side demand for shares was in the consumer products and services space and 9 of the top 10 "A-list" private companies were consumer-focused, with the 10th being SecondMarket, itself.

I thought it might be interesting to analyze some of the more lofty public company technology valuations and see if some of the more "bubbly" valuations are similarly localized.

Let's use the Screener.co stock screener to identify technology companies that are trading at high valuations using the built-in Highly Valued Technology Companies screen. This screen looks for U.S.-traded companies with market caps of over $100M and EV/Revenue ratios over 10, in the technology sector. I have manually removed all IP licensing companies from the list, as well, to focus on operating businesses. That left nine companies, as of 3/29/2011:

Company Name
Acme Packet, Inc.
ARM Holdings plc (ADR)
BroadSoft Inc
MercadoLibre, Inc.
OpenTable Inc
SINA Corporation (USA)
salesforce.com, inc.
VMware, Inc.
Youku.com Inc (ADR)
Click to enlarge

Most of these companies are good businesses that both have a track record of substantial top-line growth and a strong market position in a high-growth market. Still, as you will see below, some of the valuations are eye-popping.

Acme Packet (NASDAQ:APKT) is a unified communications company that has TTM revenue of $231.2M, a market capitalization of $4.6B, and an enterprise value of ~$4B. Its EV/Revenue ratio is a whopping 18.7x and its EV/EBITDA ratio is over 58x. Its 2011 estimated EPS is $1.08 and Yahoo Finance reports an estimated 2012 EPS of $1.44. With a share price of $69.89, that implies a two-year forward P/E ratio of 48.5x. Even with 63% YoY top-line growth YoY and strong projected growth for 2011, 2012, and into the future, this seems like a very high valuation.

ARM Holdings (NASDAQ:ARMH) is a microprocessor design firm that makes the processors used in many mobile devices--a market positioned for very strong growth. With a 17.8x EV/Revenue ratio and a 57x EV/EBITDA ratio, it had better be! The company reported 33.3% YoY growth and the consensus analyst estimate is a 2011 EPS of $0.46. However, with a share price of $17.85, that represents a forward P/E ratio of 38.8. Yahoo Finance reports a slightly more generous consensus estimate of $0.50--or a forward P/E ratio of 35.7. That is still not cheap by any stretch of the imagination.

Broadsoft (NASDAQ:BSFT) makes VoIP enablement software for VoIP providers. They reported strong 38.8% revenue growth YoY and are well-positioned in their market. But, with an EV/Revenue ratio of 11.3x and an EV/EBITDA ratio of 89x, the expectations built into this valuation are substantial. With a consensus 2011 EPS estimate of $0.62 and a share price of $43.66, that represents a forward P/E ratio of 70.4. According to Yahoo Finance, the consensus estimate for 2012 EPS is $1.02--very substantial growth. However, even if they meet those expectations, they will have a two-year forward P/E ratio of 42.8!

MercadoLibre (NASDAQ:MELI) is a Latin American e-commerce enablement company. Think eBay(NASDAQ:EBAY)/PayPal for Latin America. It is trading at an EV/Revenue ratio of 15.2x and an EV/EBITDA ratio of 41.4x. Its 2011 consensus EPS estimate is $1.61 and its share price is $76.02, implying a forward P/E ratio of 47.2. Even with a consensus 2012 EPS estimate of $2.11 according to Yahoo Finacne, that still implies a two-year forward P/E ratio of 36.0x. Yet again, another very specific high growth market with a leader trading at a very high multiple.

OpenTable (NASDAQ:OPEN) is the leader in Internet-enabling restuarant reservations. They have a strong track record of growth, with 44% YoY revenue growth. They are trading at an EV/Revenue ratio of 24.3x and an EV/EBITDA ratio of 94.3x. Its 2011 consensus EPS estimate is $1.10 and its share price is $104.29, representing a forward P/E ratio of 94.8. According to Yahoo Finance, its 2012 consensus EPS estimate is $1.66--robust growth, but still representing a two-year forward P/E ratio of 62.8! Another market leader in a high-growth market trading at an abnormally high valuation.

SINA Corporation (NASDAQ:SINA) is a Chinese media company that makes its money primarily from online advertising. Its revenue growth was only 12.3% YoY and its EV/Revenue ratio is 13.7x and its EV/EBITDA ratio is 55.5x. At this point, you get the picture...what is interesting here is that while many Chinese companies are trading at depressed valuations relative to their earnings, SINA and YOKU (discussed later) have bucked the trend and are trading at unusually high valuations.

Salesforce (NYSE:CRM) and VMWare (VWM) are both very strong brands in the CRM and server virtuatlization spaces, respectively. The server virtualization market , in particular still holds enormous growth potential. But, with EV/Revenue ratios of 10.25x for Salesforce and 10.54x for VMWare, the expectations for these companies are also incredibly high.

I've decided to save the best for last! I thought Youku, often called the "Chinese YouTube" was overvalued at $30.00/share. It is now trading at $51.15/share, repesenting a market capitalization of $5.3B; not bad for a company with $59M of revenue in its last fiscal year and most recently quarterly revenue of only $23.2M! Youku's EV/Revenue ratio is a mind-blowing 84.65x and the company only had $275k of EBITDA last quarter and was EBITDA-unprofitable for the trailing twelve month period. However, valuation discussion aside, nobody can say that the Chinese online video market will be anything other than extremely high growth and Youku is arguably the market leader.

Like the private company frothiness, the high-multiple public companies tend to be leaders in markets that are specifically targeted for high growth. As a value-oriented investor, I am very skeptical of these valuations but recognize that the "bubble-effect" is much more targeted than it was the last time around. In fact, companies like Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), and Google (NASDAQ:GOOG) are all trading at P/E ratios of less 25, not neccessarily cheap, but certainly not laughable. I think this is definitely a different type of bubble, one where the run-ups in valuations are much more localized and confined to specific companies and markets rather than an entire sector or industry.

Disclosure: I am long MSFT, GOOG.