Are We In Another Tech Bubble...Or Something Different?

by: Lenny Grover

There has been a lot of discussion recently about whether we are in another tech bubble like what we saw in the late 1990s. Believe it or not, I actually weighed in on this topic on Seeking Alpha in March 2011. I argued that there were localized bubbles in the tech sector and that, rather than the entire sector being overvalued, we were seeing frothy valuation in very specific markets within the tech sector. While many of the companies in that article have seen their valuations decline markedly, I would characterize none of them as cheap today. Furthermore, other recent IPOs have joined the list of public tech companies enjoying bubbly valuations. I believe that my original hypothesis continues to reflect the current public market for tech companies.

To illustrate the point, I used the equity research platform to find public companies trading on U.S. exchanges with EV/Revenue ratios of greater than 10. I backed out IP holding companies with unpredictable revenue and chose 6 of the most recognizable companies.

Company Name EV/Revenue Revenue (FY)
Splunk (NASDAQ:SPLK) 26.6x $121M
LinkedIn (NYSE:LNKD) 20.3x $522M
Jive (NASDAQ:JIVE) 17.1x $77.3M
Youku (NYSE:YOKU) 15.3x $142M
NetSuite (NYSE:N) 11.7x $236M
VMWare (NYSE:VMW) 10.8x $3.8B

* Data as of market close on 4/30

All of the listed companies have valuations in excess of $1B even though Splunk, Jive, Youku, and NetSuite are unprofitable (excluding extraordinary items) over the trailing twelve month period. While those arguing against the existence of a tech bubble point to more sensible large-cap tech valuations, they neglect to mention that the social networking/Internet, SaaS, and virtualization markets represented by the companies above still have frothy valuations.

I am, by no stretch of the imagination, bearish on the long-term prospects of those markets but one of the key points I have made in earlier articles is that valuation matters! At a $10+B valuation, bulls are effectively arguing that LinkedIn's future cash flows are worth more than those of Western Digital (NYSE:WDC), a company with $9.5B of revenue and $726M of net income in 2011 (to LinkedIn's $522M revenue and $6.92M of net income). That's crazy -- even when accounting for WDC's cyclicality and LNKD's projected growth rate!

I have the utmost respect for tech industry luminaries like Marc Andresson, Fred Wilson, and others who have argued that we are not in a tech bubble. But, it would be wise of them to point out that what we see in the example above is not reflective of rational or normal market conditions. There are tech sector micro-bubbles that investors need to be wary of as they navigate the volatile market we find ourselves in.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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