The Economist Website ran a very interesting debate in June 2011, the title of which was:
“This house believes that we are in a new tech bubble.”
The full debate can be found at http://www.economist.com/debate/days/view/710. The motion was proposed by Steve Blank, a lecturer and retired serial entrepreneur. The motion was opposed by Ben Horowitz, General Partner of Andreessen Horowitz.
So the first question is what does a bubble look like and how can we define and describe its stages?
4 Phases of a Bubble as observed by Dr Jean-Paul Rogrigue in the Department of Global Studies & Geography at Hofstra University. You can find out more about his fascinating approach at his blog here. His excellent definition of a bubble is posted under the heading of “Bubbles, Manias and Bears, oh my…(01/18/2006) and is further down his blog page.
Stealth; Smart Money ;early stage investors invest in an industry or market segment; social networks, consumer and mobile applications and the cloud.
Awareness; later stage investors start to notice the opportunity and rush in to try to get a piece of the action and push prices higher. Media supports this with increased coverage and explanations of the difference this time round.
Mania: Public jump in for the investment opportunity of a lifetime; the wave of dumb money pushes valuations into the stratosphere; The higher it gets, the more the public want to invest, While this is going on the smart money and many institutional investors are quietly taking profits and exiting; as new heights are reached, investors with no knowledge of the fundamentals join the rush – greed becomes the main motivation
Blow-off: Valuations plummet and late stage dumb investors join the 98% club (98% losses on their investment), oh yes and the smart money starts to re-accumulate assets at rock bottom prices.
Another Way of looking at it (follow the curve in the diagram…):
- Take Off
- First Sell off
- Bear Trap
- Media Attention
- New Paradigm
- Bull Trap
- Return to the Mean
So Are we in a Tech Bubble?
In the Economist online debate, Steve Blank put forward the Proposer’s argument broadly as follows:
VC firms are chasing private company valuations in upward spirals as they compete to be able to participate in funding rounds. Examples include Groupon who recently filed for an IPO citing a potential $15 billion valuation, Facebook now rumoured to be valued at $70 billion.
Further evidence might be cited from the sale of Ning. As I noted in my recent Six Minute Strategist Eye Piece, Ning received VC investment at valuations in excess of $500m but sold to Glam Media for a reported $150m.
The key question is whether companies being valued in excess of their fundamental valuations? The Proposer’s view was firmly that they are.
The Opposer of the Motion, Ben Horowitz, took the following position:
What has changed since the last tech bubble, he asked? Three key factors.
- Costs 100 times lower,
- Programmer productivity 10x higher,
- Market 20x bigger
Will the market double in size again in 5 years time? He thought it would at least dothis and cited an IDC – forecast 1 billion mobile internet users by 2013 – today there are 4.5 billion phones worldwide and he thought the growth of smart phones would escalate.
Another argument for “its different this time” was Disintermediation.
Internet and Software – disintermediating traditional industries and business models
- Magazines and newspapers
- Music distribution
- Animated Film
- Direct marketing
- Oil and Gas?
- Financial Services?
- Local business?
I have the following observations:
The Key assumption that these businesses can monetise the market opportunity to the same extent but much of the expectation is that many internet businesses should be offering free solutions and services
Surely it the VCs in Silicon Valley who have created an artificial market and are living in a bubble. I call this the Silicon Valley Effect. When they need a financing event they try to persuade IPO investors to take stakes in these companies at these over priced levels.
How do you value market disruption when much of the actual means of disruption is still not yet clear, and nor are the winners in these markets? Picking winners is notoriously hard to do
Are the current market winners a good proxy for valuations of start up companies. me-too competitors and those outside the golden group of market leaders. The numbers of companies actually achieving stratospheric valuations at the moment is relatively small compared to the numbers of businesses being created, partly as a consequence of the change in the market noted by Horowitz and cited above.
Where is the next level of innovation coming from? Silicon Valley seems to be in a derivative phase. See my recent post 6MS Eye Piece 19 Sep 2011 – The new KISS Principle?
Sustainable Competitive Advantage – has this gone out of fashion?
I believe that we now entering the new stage of 2nd Generation Social Media where the platform winners are now established – Google, Facebook, Twitter et al. The challenge is for new companies now provide derivative products and services to support these platforms. What do you think? Is the first phase of the Social Media revolution now over?
In conclusion, I think that the Private Equity and Venture Capital investors are certainly doing their best to create the conditions for a bubble and the early indicators are there. For the vast majority of tech firms seeking investment, this exuberance means very little. It is still difficult to raise capital and most firms are still having to accept conservative valuations from investors who, given the relative scarcity of capital from other sources, currently hold the stronger hand.
Look at the Curve on the graph above and ask yourself two questions:
1. Where do you think we are on the curve?
2. What sort of investor am I?
If you can recognise where we are and what is going on in the market, you can start to think and act like the Smart Money.
Two final points.
If you are thinking of making an investment decision and your motivation is excitement rather than analysis – pull back!
When you get pitched an internet business by a taxi driver (this happened to me in 1999), be afraid…be very afraid!
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