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  • Dot-Bombs 2.0: A Look At The Inflating Tech Bubble  0 comments
    Apr 16, 2014 11:00 AM

    Dot-bombs 2.0: A look at the inflating tech bubble

    The Dot-com boom of the late '90s saw the expedient rise in stock value for many venture capital-backed tech companies, as they battled for market share while operating at a loss quarter after quarter. As the '90s came to a close, the house of cards collapsed and numerous "dot-bombs"imploded as their coffers ran dry and they were forced to close up shop. Like all bubbles there was an honest impetus for the growth on some level, and giants of the industry like Google, Apple, and Samsung came out of the burst and steamed ahead, proving a decade later that it wasn't all just smoke and mirrors. A quick glance at the recent activity coming out of California's Silicon Valley though shows that the lessons of history may have been forgotten; there is every indication that we are witnessing the inflation of the Web 2.0 bubble, and you don't have to be Nostradamus to predict what's coming next.

    While the first Dot-com boom was driven by the boundless opportunities presented by the still young World Wide Web, this iteration has grown around the phenomena of Web 2.0 - specifically the advent of social media and other user-generated, and collaborative products and services. Unlike the bubble of the '90s though, even the behemoths of Web 2.0 have not proved beyond the shadow of a doubt that they have the staying power to truly justify the Goliath valuations that they received prior to their IPOs. This sheds light on the crux of the Web 2.0 issue, which is overvaluation and unreliable projections of future growth. A simple look at two of the recent IPOs to come out of Silicon Valley can serve as an illustration of what is a systemic problem in the contemporary technology sector.

    1. Facebook (NASDAQ:FB) -With a market cap exceeding $144B and share price breaking $60.00 in the first quarter of 2014, there is no doubt that Facebook is the Web 2.0 analogue to Google (in more ways than one). The social start-up with over a billion users globally derives the majority of their revenues from its advertising business, and even has a Disneyland-esque campus in the heart of Silicon Valley.

    The reason that Facebook's success needs to be taken with a grain of salt is because of the unwarranted excitement that it causes in investment circle. At the time of their IPO in 2012, Facebook was valued at $104B, which made it the third-largest IPO in U.S. history. To drive home just how much demand there was for Facebook at the time, Google was valued at a the partly sum of $26.4B at the time of their IPO in 2004. The tremendous valuation was made despite a slow-down in revenue in the months leading up to the IPO, as well as a relative lack of understanding as to how the company would use the money generated from the IPO to expand revenue globally in the coming years.

    After one of the largest IPO debacles in modern history, which saw their opening share price of $38 drop by approximately $20 in 4 months, the stock has absolutely rebounded. That being said… the bungled launch was a result of overvaluation and technical errors (the latter on the part of the NASDAQ), and it was an ominous signal of things to come.

    1. Twitter (NYSE:TWTR) -Unlike its social media contemporary Facebook, Twitter had an IPO that was anything but disastrous. The stock was priced at $26, and the first trade of the day registered at $45 a share. By the end of its first day of trading, Twitter stock was trading at 73% above the IPO price. At the time of its IPO in November the company had a market cap of $25B, and many analysts suggested that they "left money on the table," after the price shot through the roof immediately after hitting the exchange floor.

    Now, with all of the success enjoyed by Twitter last November, what could be the problem? The problem is that all of this activity centered on a company that, at the time of its IPO, had never earned a profit. Not only had Twitter never earned a profit, they were coming off a three year period where they accrued approximately $300M in losses; $65M of those losses came in the quarter prior alone. Analysts projected Twitters future growth potential using all of the tools in a speculators tool-kit, and in the process added ever more air into the fast-inflating tech bubble.

    The gratuitous valuations of both companies illustrate that too much confidence is being placed in an industry that, as of yet, has not proved itself as a viable, long-term industry. Social media technology companies and the larger Web 2.0 space have seen a tremendous influx of venture capital money over a period where virtually all other sectors of the economy are contracting, or seeing near-stagnant growth at best. While there is money to be made in the world of the user-driven, the industry has yet to provide a truly solid example of revenue generation that is not solely dependent on advertisements (a medium that is not just competitive, but can be fickly as well).

    The savvy investor would do well to not jump too quickly onto any of the tech bandwagons that are increasingly setting out into the world of publicly traded companies. While there is certainly money to be made riding the bubble to the top (it wouldn't be a true bubble if there wasn't), in the wake of the recent real estate bubble burst, and Web 1.0 prior to that, an old saying comes to mind:

    "Insanity is doing the same thing over and over again and expecting different results"

    -Albert Einstein

    Steering clear of the current tech craze until the market settles into a more sustainable pattern would be the prudent move. Web 2.0 will shake out in the mid-term, and the social contemporaries of Google, Apple, and other tech giants will mark out their fiefdoms with more than large IPOs, but large (and sustainable) revenues. Riding the "boom" rollercoaster for another time in the same industry, and hoping again you have the foresight to jump off the ride before it finally crashes is surely the type of behavior that Einstein was referring to.

    When talking about the future of stocks it is always relevant to close with an insight from the billionaire, and investment wizard Warren Buffet. He gives us a simple way to think about investments and risk when he says "never test the depth of a river with both feet". Nutmeg, a UK ISA investment company, eloquently summarize Buffet's philosophy. Don't overcommit during to a sector when there is a vale of uncertainty.

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