If You Think This Is A Bubble, You're Out Of Touch

by: SA Editor Rocco Pendola

Granted, that's pretty harsh.

Howard Lindzon made the point with quite a bit more eloquence in a blog post, There is NO Bubble... There is Entrepreneur Envy, last July:

The Internet of 1999 was a mania. What we are seeing today in web/tech is a phenomenon. People can't value social graphs. It's too new. Thousands of companies are starting because the opportunity to lay a claim in this phenomenon is possible.

... entrepreneurs are chasing dreams with little bits of angel and venture money. Companies with massive opportunity and now loads of cash are going public and dominating their verticals or mindshare. That's not a bubble ...

We are in the early stages of a cycle and we need as much enthusiasm as we can get. There will be oodles of time for bubble talk in 2015.

Heads down please.

Now's that quality qualitative thinking. And don't gloss over the "heads down" part because it's vitally important. Lindzon also called the public "imbeciles" in part of his piece that I did not quote. That's important as well.

So, again, I reiterate. We are not in an IPO bubble or whatever you want to call it and if you think we are, well, pick your childish taunt and paint it on your forehead.

But, as Lindzon pointed out there's no shortage of folks calling him and asking about it. I'm sure that's still the case to this day.

Consider somebody named Sean Williams from Motley Fool, who, in Is the IPO Market Headed Right Back to 1999 All Over Again?, wrote:

1999 was an interesting year to be an investor to say the least. 486 companies went public with eight logging gains of greater than 350% on their first day of trading. As we learned years later, these valuations simply weren't sustainable, and many of these companies either perished or are nowhere near where they once were.

After cherry-picking some 1999-ish IPOs that skyrocketed only to flop, Williams goes on to ask:

Have IPO investors really learned anything since 1999? I'm not inclined to think so.

Take a look at last year's class of Internet IPOs and tell me if you notice a trend. Also, keep in mind as a comparison that the average S&P 500 company trades closer to two times book value and seven times cash flow.

Williams then pulls out Price/Book, Forward PE and Price/Cash Flow data on several fresh IPOs. Again, not trying to be harsh, but his analysis and comparison between 1999 and now is nothing short of clueless.

Williams goes on to make matters worse for himself with another ill-advised and wholly errant attempt at the parallel bars:

Pandora Media (NYSE:P) relies on advertising to generate more than 85% of its revenue, and the last time I checked, the vast majority of Internet-based companies that relied on ads for their revenue back in 2000 perished.

Yikes. Where to begin?

To make an Apples to Apples comparison let's consider the stocks Williams pulls from 1999. Here's the chart he put together:

Click to enlarge

Let's make a more relevant comparison between yesterday's and today's IPOs:

  • Pandora (P): Opened at $20.00. Hit intraday high of $26.00 on first day of trading. Closed at $17.42. That's a loss. Now trades for around $13.50-$14.00. Even lower still.
  • Renren (NYSE:RENN): Opened at $19.50. Hit intraday high of $24.00 on first day of trading. Closed at $18.01. That's a loss. Now trades for roughly $5.19. Not good at all.
  • Zynga (NASDAQ:ZNGA): Opened at $11.00. Hit intraday high of $11.50 on first day of trading. Close at $9.50. Another loss. Now trades for about $13.50 a share. Nice gain.
  • Tudou Holdings (NASDAQ:TUDO): Opened at $25.11. Hit intraday high of $27.75 on first fay of trading. Closed at $25.56. Small gain. At last check, TUDO trades for $14.62.
  • LinkedIn (NYSE:LNKD): Opened at $83.00. Hit intraday high of $122.70 on first day of trading. Closed at $94.25. Solid performance. Now trades for $76.87.

Of course, Williams will say, "But, I was showing that they're still overvalued." That misses several points.

First, the obvious. The only first-day close that Williams printed from 2011 that even comes close to 1999 is LNKD, which finished up 13.6%. And LNKD, like most of the recent Internet IPOs, not only rose much more slowly, if at all, but fell faster, but in a somewhat more "controlled" fashion.

This tells me much of what I need to know. We have "learned" whatever there was to learn from 1999. Investors no longer run IPOs up by 300%, 400% and 500% on their first day of trading or, generally, anytime thereafter.

But, the more qualitative (and excellent and certainly more thoughtful) analysis from Lindzon matters even more.

"Heads Down Please"

Lindzon understands perpetual start-up mode. People like Williams do not. In a Seeking Alpha article published Tuesday, I pulled something from Adam Lashinsky's new book, Inside Apple, that's apropos:

Steve Jobs would tell his developers, designers and engineers what he wanted. Often, it was literally impossible. Yet, he would not take no for an answer. A small team, often of one or two, would work behind closed doors and, lo and behold, they would come out with the answer. That's how a start-up runs. And that's how successful tech companies need to approach a world dominated by Apple.

Apple (NASDAQ:AAPL) and Amazon.com (NASDAQ:AMZN) - perpetual start-ups.

I wonder if Williams knows who Woody Shackleton is. He's a former IBM (NYSE:IBM) executive who was the VP of Sales for Foundry Networks when it went public as FDRY. He became one of those Silicon Valley instant millionaires.

Back in 1999 and 2000, my job was to cold call people like Shackleton and try to talk them into buying sports hospitality packages for anywhere from $20,000 to over $100,000. Shackleton was one of my biggest clients. Clearly I had a ton of interaction with the guy. And whenever I called the office - five in the morning, ten at night - he was there.

Like Apple and Amazon employees, Shackleton had his head down. He was going to become a millionaire whether Foundry rose 500% on day one or flopped like so many of the last year or two's IPOs have. That raises two important points. One, it's tough working for a company in perpetual start-up mode. But, one thing's for certain, you're not focused on the stock price during your 16-20 hour days. And, two, IPOs are volatile issues. Always have been, always will be. As a retail investor, you probably should stay away until the dust settles and then only buy companies you believe in.

Valuation Means Little

I'm not sure how many times we have to have this debate. Like Marino or Montana and Gretzky or Lemieux, it will likely rage forever. But, cats like Williams constantly misread what a P/E and most other metrics that gauge "value" in relation to stock price mean. Or, at least, what they should mean to long-term investors.

Based on what he wrote in the article I am addressing, it's probably a safe bet that Williams would call AMZN overvalued. I guess it's part of the bubble. Its forward P/E is a ripe 69. But the number is not the point. You should take bullish meaning from stocks - with strong, innovative and pioneering businesses that are in perpetual start-up mode - that the quants "over-value."

I am not saying that every stock on the recent IPO list is a buy. I probably think less than half of the stocks on the S&P 500 (NYSEARCA:SPY) or Nasdaq 100 (NASDAQ:QQQ) are buys. And it's got nothing to do with value. It has everything to do with their growth, their ability to grow in the future, their business model, the size of their opportunity and their competitive-strategic position with relation to seizing that opportunity.

Williams points out that Pandora relies on advertising for 85% of its revenue, suggesting that it's not sustainable. Google (NASDAQ:GOOG), with a forward P/E of just 12, counts on advertising for nearly 100% of its revenue. To understand a company like Pandora (or Google or Amazon or the other perpetual start-ups), you have to be able to take your thinking to a higher level. You need to be able to think big picture. Conceptually.

That brings to mind my favorite quote from the last hope in American politics, Robert Kennedy:

There are those who look at things the way they are, and ask why ... I dream of things that never were, and ask why not?

If you're an investor and you focus on valuation today, you will underperform. If you are a company and you cannot figure out how to spend your free cash as you grow revenue slowly in rapidly-expanding sectors, you will underperform. That's the biggest gripe I have about Sirius XM (NASDAQ:SIRI). How in the world can a company sitting in the audio entertainment space sit there and stew over how to spend its money? It's mind-boggling.

Put your head down, vision the future and reinvest in your business.

Pandora generates 85% of its revenue from advertising because that's where massive opportunity lies. It has barely broken the seal in terms of what's possible in the mobile space. And it still has loads of market share to take away from broadcast radio. Pandora employees have their heads down, with tunnel vision set on the goals. And the company spends the cash to grow, not to stabilize the stock price or satisfy short-term investors. Companies like Pandora and Amazon sacrifice parts of the bottom line today to ensure they'll be in excellent positions as leaders of their spaces tomorrow.

To reiterate, I am not saying to run out and invest your IRA in RENN tomorrow, or any other IPO or tech or Internet company. What I am saying is do more than surface-scratch analysis. We have not come to laud Steve Jobs, Jeff Bezos, Mark Zuckerberg and people like them because they could tell you their company's Price/Cash Flow number at will.

We admire them because they had the vision to change some slice of the way we live. As an investor, you need to be part-visionary and less of a number cruncher because quite frequently the numbers do not tell even half of the meaningful story.

Disclosure: I am long AAPL, P.