More on the new internet bubble

There is definitely a technology bubble brewing. And it will end badly. Some people are going to get rich though – and not necessarily undeservedly so. Some thoughts below

I am going to make this very short. Valuations in the private Internet space are out of control and they have been for some time. This hasn’t necessarily carried over into the valuation of more mature tech companies, with Cisco, Microsoft, and Apple all trading around 16-17x earnings. But the less mature public companies with a tech component all have valuations which are hard to reconcile with the fundamentals: Facebook, Tesla, and Netflix come to mind here.

And of course, this makes sense as we are in the second Internet gold rush. I am a big, big fan of the new mobile software, hardware and platforms coming out right now. A lot of value is being created. As I put it when I last spoke of the new Internet bubble in June, “we are in a land grab in the technology sector as the industry moves away from the PC to a more mobile and cloud-centric universe. The dynamics of that kind of paradigm shift make manias likely, even inevitable because an investment in companies coming to prominence in this space right now is like buying a call option with huge amounts of implied volatility. That optionality is worth a lot of money – so much that it creates the kind of price movements that naturally lead to bubbles or manias.”

And as we know, bubbles and manias end in tears. Everyone gets hurt to some degree, some more than others.

I bring this up because Bloomberg has a very good article on what is driving the bubble higher that I highly recommend you read. The link is here. But let me highlight a few sentences I think are the mos t important to focus on.

…valuations are just a placeholder number, part of an equation fueled by other, more important factors. Those can include market share, growth projections, and a founder’s ego….”

“These big numbers almost don’t matter,” says Randy Komisar, a partner at venture firm Kleiner Perkins Caufield & Byers. “Those numbers are just a middling shot at a valuation, and then it’s adjusted later” through various legal techniques, if an earlier valuation was too high, he says.

For Uber to get to $40 billion or Airbnb to $20 billion, you’d need to get a little creative with the variables underlying that logic. Since private tech companies often lack earnings or enough historical data to inform projections—or, in the case of Snapchat, any significant revenue—investors can’t rely on the metrics available for public companies. If there were a math problem for determining a tech startup’s valuation (for the record, there isn’t)…:

Here’s the takeaway: we are talking about optionality here. Every sentence in that part of the Bloomberg essay points to companies that in the present environment could be worth tens or even hundreds of billions of dollars. They could be massively undervalued. We just don’t know. Those same companies could also go to zero, of course. And again, we just don’t know. I wrote the same thing in May to describe what I call mobile disintermediation, by the way.

So what happens then; what do investors do? They buy these options, hoping that they make good choices, even knowing that the mania will end badly. This is the herding behavior that manias create. Some people will win and get very, very rich, but most people will lose.

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