I was joking on the stream yesterday with Josh Brown about how he hadn’t received the memo that the world was now operating on two month full adoption and dispursion cycles when it comes to social networks. The joke was brought on by someone with data claiming that users of Google+ (GOOG) were already starting to spend less time on the site, and therefore the network had already peaked; a whole 3 weeks into its existence.
While this joke was meant to highlight how jaded some in the tech community have gotten regarding the crazy growth and disruption that we are currently seeing across many different platforms, there is some truth behind every caricature. It’s unholy and ridiculous to be sighting a change in trend of Google+ time on site stats after just three weeks. But there is a deeper truth to just how quickly we are seeing communities, platforms, networks, and businesses on the web erected, and how quickly they are disrupting both long entrenched industries, and each other.
As you know, I do not believe we are yet in any type of tech bubble 2.0. The statistics don’t corroborate that line of thinking, and many are confusing anecdotes of a true economic boom with a bubble; in many ways they look the same. We may eventually end up in a bubble, as all booms end that way, But it isn’t worth talking about right now, it is at least five years away, maybe 10. As I have written in the past, stop trying to predict when the eventual bubble will pop, and focus on taking advantage of the boom now while keeping your eyes peeled for red flags.
While I don’t believe we are in a bubble, I do believe that investors are suffering from the lack of understanding of what I like to call disruption risk. At no point in history has it been easier to disrupt whole industries in such short time. And at no time in history has it been more perilous for new companies to be disrupted so quickly themselves after such high growth over a short period of time. On both sides, disruption is taking place at monumental speed and scope. Investors are flailing around trying to understand how to invest and value assets based on this new paradigm. I believe this misunderstanding is contributing greatly to the belief of some that we are in a bubble.
Disruption risk cuts both ways, it can both add and subtract value from your company. The fastest growing social networks are currently being valued at around 40 times revenue due to the belief that they will disrupt large swaths of our economy down the road. The bet is that their upside exceeds what we may be able to even consider their business models to be.
Is this irrational? Maybe, maybe not. But in a world where disruption is taking place at these types of speeds, what makes you the person who knows how to value these businesses 3-4-5 years from now? LinkedIn (LNKD) is crushing Monster (MWW) and just released the 'Apply with LinkedIn' button that will soon be on every recruiting page of every business’ web site on earth. What is it worth to have a LinkedIn page be on everyone’s resume, and to apply to any job so seamlessly? How about the value of being able to automatically see which of your connections works at that company and request they put in a good word for you with a few clicks. Does that completely change the way companies hire? Maybe.
The point here is that the potential of web 2.0 is for massive disruption of so many different industries, and the erection of completely new ones, quickly. This type of disruption risk is juicing valuations across the board, and rightfully so. While we don’t know what the future cash flows of these companies will look like, we do know that they are generating revenue faster than ever before on a scale never seen before.
But there is a whole other side to disruption risk, the downside, the side that I don’t believe is being correctly priced by the market. I will use a few examples here.
First, old economy companies that are being disrupted by new economy web 2.0 companies. Investors are just not valuing these companies correctly based on their potential to be completely decimated within half a decade, if not faster. Look at how fast Blockbuster (OTC:BLOAQ) was destroyed by Netflix (NFLX), how fast Amazon (AMZN) killed both Borders (OTC:BGPIQ) and Barnes & Noble (BKS) and soon Best Buy (BBY), how fast Zynga (ZYNG) is killing GameStop (GME). These are just a few examples. Disruption is taking place at breakneck speed and investors in old economy companies are not properly accounting for this risk. I can rattle off another dozen companies that are at perilous risk of getting disrupted or are in the early process right now. Hell, look at Monster, it brought job searching online only a few years ago, and already LinkedIn is destroying them. It’s crazy.
Second, new economy companies that have “made it” are at risk of being disrupted as well. I give you the perfect example in Facebook which I am getting getting more and more bearish on every day. On a scale of 1 to 10, 10 being the most bullish, 5 being completely neutral, I’d say I’m about a 4.5 right now, where six months ago I was a 10.
Why has my stance changed so drastically, so quickly? Because Facebook has become the internet for idiots and is about to be disrupted by a whole slew of companies gunning to eat away at the social media empire it has built. They are in effect the Craigslist of web 2.0. Is anyone accounting for the potential that Facebook is disrupted over the next 3-5 years and cannot find business models to produce revenue deserving of a 40X multiple? I don’t think so, and neither are the current investors, obviously. Valuation only matters on the way down. But when “how the way down might take place” comes more into view and becomes more realistic in the near future, you have to look at your risk. Facebook has a ton of it now, and I believe it may have run out of the good kind of disruption risk.
So when the Facebook IPO comes out at 100 billion dollars in market cap, I’m at least neutral, if not bearish. I wouldn’t be a short for reasons that purely have to do with market structure, but I sure as hell wouldn’t be a long term holder of the stock. I would be selling my stock into the offering and secondary offerings if I’m a shareholder now.
To highlight another example of bad disruption risk in web 2.0 companies, I give you DropBox. This is an extremely innovative company with an amazing product, one that I personally use and love. It is now valued at around 5 billion dollars.
If DropBox was able to operate in a vacuum for the next 5-10 years, it would most likely be a home run company from here. To be able to store all of your info in the cloud and access/share it with anyone-- amazing. But the barriers to disrupting DropBox are sooooo small. Apple (AAPL) will roll out iOS5 soon, and will destroy the user base of DropBox which has Apple products, including myself. Is the market discounting the risk that DropBox will be nothing more than a commodity soon? I think not. And so many other web 2.0 startups will soon be commodities. Are they really worth the multiples they are getting, given that possibility?
Tech bubble 1.0 was about the possibility of revenue. During this boom we are seeing web 2.0 companies generate that revenue, and some generate huge profits as well. But I don’t believe that for some companies the market should be extrapolating as far out as it is, the risk of being disrupted before that takes place is getting higher and higher. LinkedIn doesn’t have that risk, DropBox and Groupon (GRPN) obviously do. Not all companies should be getting the same disruption boost.
In the end I believe it just comes down to things moving faster and investors not being prepared for it. Only 12 months ago Groupon looked like an amazing business, it was literally the fastest growing company ever. Now their model looks broken because of shrinking margins and soon disruption by Google. It will take time for investors to reprice this type of risk, on both the upside and downside. Right now it’s all upside, but make no mistake, there will be a lot of pain felt when a huge new platform with a 30-40X multiple gets disrupted. That’s not a bubble, that’s just disruption risk.