The case for there being a bubble in networking technology IPOs has been made ad infinitum, so I’ll start with that as being accepted; those in denial should spend some time reading Early Speculative Bubbles and Increases in the Money Supply and then looking up the reported MZM statistics. We’re getting on the steeper part of the incline on that MZM chart, so there’s going to be a bubble somewhere in the US dollar economy; the venture capital industry is reporting larger fund sizes, with greater concentration of wealth within funds, so it appears that the increase in MZM is finding its way here, blowing a bubble in the process.
For investors, that means the current crop of web IPOs is just like Bubble 1.0: Not worth buying unless you’re an active trader. But don’t be deceived: The Internet is still going to be an amazing source of value creation and profit extraction. Over the next 25 years, the world will be completely rewired by networking technology. I believe this will be a key driving factor of the next secular bull market, the one that emerges once the global economy has solved the sovereign debt crisis.
If the world really will be rewired -- perhaps by the Android (NASDAQ:GOOG) ecosystem, its rivals, and its descendants -- then what is the investment opportunity? How can investors maximize the opportunity here?
The key is the virtual currency. We are already seeing this now; popular social gaming company Zynga (ZYNG) generates its profits through currency issuance. Given that Zynga has a deep partnership with Facebook and is partially owned by Google, we can see how the virtual currency is shaping up to be the cornerstone of the next networking technology platform; in other words, the virtual currency is “the new search," the means of monetizing web activity, specifically social networking, in a way that unleashes a whole new economic ecosystem -- just like what Google’s search engine and text ads did for the web starting over a decade ago.
The biggest challenge to actualizing this enormous market opportunity, though, is legislative. Eventually these virtual currencies will take on the dynamics of real currencies and will be expected to serve as a store of wealth, redeemable for something that has real value. This will be seen as a threat to nation-state economies; indeed, China has already sought to restrain virtual currency usage. US legislators and bureaucrats seem particularly concerned about the impact of competing currencies on the US economy; the US Securities and Exchange Commission nearly banned foreign exchange trading, and Senator Charles Schumer has sought to ban Bitcoin, a virtual currency sysem, on the grounds that it is a means of money laundering.
Ultimately, the real opportunity for web companies is in selling virtual currency; it is an extremely high margin business that relies on network effects -- the cornerstone of value creation and profit extracting in the networking technology sector. Niche platforms build on Android will increasingly be delineated and monetized by virtual currencies; these currencies are essential to re-wiring our organizations and our economies, and thus are essential to the networking revolution.
Until networking technology companies learn to deal with this situation and navigate the legal environment accordingly, the growth of all these big consumer networking plays -- Zynga, Twitter, Pandora (NYSE:P), LinkedIn (LNKD), Groupon (NASDAQ:GRPN), Foursquare, Zillow (NASDAQ:Z) -- will be limited. If they think they can operate as a mass advertising business, they will be competing directly with Google in its most prized domain. And even hardware companies that plan to bring a product to market will increasingly need to develop and manage developer communities, and a virtual currency with real economic power is essential to this process.
The opportunity is great, truly world-changing. Whether or not we have the political will to actualize this opportunity, though, is a different question. And until we have that will, the investment opportunity for big growth plays will be severely limited.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.