All Tech Considered
Mon April 16, 2012
Another Tech Bubble? Maybe Not
Originally published on Mon April 16, 2012 4:16 pm
It's beginning to feel frothy in Silicon Valley. Here are a few numbers:
On the first day of its initial public offering LinkedIn was valued at nearly $9 billion; today the social networking site is worth more than $10 billion. Instagram, a company with no profits, no revenue and no plan to make money, was just bought for a cool billion. The buyer was Facebook, a firm in the process of going public.
And those values are nothing compared with what Facebook may be worth itself. That company is expected to be valued at between $80 billion and $100 billion after its IPO later this spring.
But is this a bubble? Is the considerable exuberance in this part of the world irrational?
Here in Silicon Valley you hear some version of this statement all the time: "This is different. I was here in the 1990s and these companies are not Pets.com."
Investors and entrepreneurs have been saying this to each other for years, in part because it is true. Facebook generated $1 billion in profit last year. It's still almost doubling its revenue and profit year to year and it's doing all of that with a relatively small workforce.
Instagram created a social network of 30 million people with just over a dozen employees. These companies have created ways to connect millions and build enormous audiences incredibly efficiently. That is worth something. The question is, what?
Steve Blank is a serial entrepreneur in Silicon Valley and an adjunct professor at Columbia Business School. He says we have sailed through the stealth phase of the current technology investment cycle. We are past the point where big investors are aware of the opportunities in mobile and social companies and we're rapidly entering into a period of manic excitement of the next wave of Internet companies.
But Blank says not all bubbles are created equal — not all bubbles are bad. "Bubbles built the railroads," he says. "Bubbles built the steel industry." He believes many of the technologies that are attracting so much excitement right now have the potential to change the way we live and how the economy works.
That may be. But prices are high enough now that many wonder whether companies like Facebook can justify their own hype. When investors talk about bubbles, typically they end up comparing a company's profits with its share price. The price-to-earnings ratio is a staple of evaluating a stock. ExxonMobil's P/E ratio hovers around 10. That means the company is valued at something like 10 times its annual profit.
Apple has a P/E ratio of 17. That's high compared with historical averages, but Apple's earnings have been growing incredibly fast and the company is sitting on $100 billion in cash. And its stock looks positively cheap in comparison with the latest crop of social media companies that are going public.
If after Facebook's initial public offering it's valued at more than $100 billion it will have a P/E ratio of 100 to 1. And that's a bargain compared with LinkedIn, which is trading at a ratio of between 800 and 900 to 1. These are bubblicious prices.
To justify its projected IPO price to more conventional investors, Facebook will need to double its earnings every year for the next three or four years. Those who sell now may realize windfalls and those who buy have to hope for years of exceptional growth or they will be left holding the bag.
But Blank says this may not be bad news for the economy as a whole.
"Unlike other bubbles — housing bubbles and financial bubbles — nerds don't buy yachts. They seem to reinvest in their own domain," he says.
Technology entrepreneurs who strike it rich often end up pouring a significant amount of their wealth back into new companies founded by friends and colleagues.
The most famous example is the PayPal mafia. The original investors and founders of PayPal have helped launch dozens of companies, seeding them with money and expertise. Those firms included LinkedIn, Zynga, Facebook, SpaceX and Tesla, to name just a few.
Younger generations of entrepreneurs reinvest this way as well. Rather than turning over their newfound fortunes to Goldman Sachs, entrepreneurs here tend to look around for other technology ideas that seem clever and entrepreneurs who remind them of themselves.
Take Aaron Patzer. He founded Mint.com in his early 20s and sold it to Intuit a few years later for $170 million. Patzer then invested a bit of his windfall in Milo, whose founder, Jack Abraham, was also young and hungry. Within months Abraham sold his business to eBay for $75 million. Abraham then invested in Pinterest, which now is one of the hottest social startups in the country.
Stories like this repeat again and again and again. And Blank believes that makes a tech bubble — at least this tech bubble — more productive than others where investors in effect take their winnings off the table. Each new windfall leads to a new round of investment. Maybe some firms are sold for too much, but in the end much of the money is reinvested in innovation.
"The last 10 years have taught us a ton about what the next 10 years are going to be," Blank says. "We are much smarter, much better, much more efficient at building early-stage ventures."
As more technology entrepreneurs experience big paydays, Blank is optimistic about what the next wave of investment could bring.
"We actually think we have found a way to take the most advanced research in our labs and insert it into our economy," he says.
AUDIE CORNISH, HOST:
From NPR News, this is ALL THINGS CONSIDERED. I'm Audie Cornish and it's time now for All Tech Considered.
This week, we wrestle with a question that could have big implications for the U.S. economy. Are we in the middle of the next tech bubble? First, a few numbers. On the first day of its initial public offering, LinkedIn is valued at nearly $9 billion. And that's nothing compared to Instagram; Facebook dropped a billion dollars to buy that company last week, even though the tiny photo-sharing start-up brings in no money at all.
Then again, with Facebook's own value drawing estimates of 75, even $100 billion, what's a billion here or there? Well, to some, these dollar signs are warning signs.
For more, we're joined by NPR technology reporter Steve Henn. Welcome, Steve.
STEVE HENN, BYLINE: Hi.
CORNISH: And we're also joined by Steve Blank, a Silicon Valley entrepreneur and now adjunct professor at Columbia Business School.
Hi there, Steve Blank.
STEVE BLANK: Hi, great to be here.
CORNISH: So, let's start with some ground rules here. Steve Henn, exactly what is the definition of a tech bubble? I understand there at least four stages.
HENN: Yeah, I think most people think of bubbles as investment manias that are formed by irrational exuberance. But a professor at Hofstra, Jean-Paul Rodrigue, outlined how a bubble gets started, how it grows, and then how it bursts. And it's become pretty popular to talk about the four stages of bubbles, starting with the stealth stage, where really smart investors recognize a really big opportunity and start pouring money in. And then, slowly, awareness of that opportunity builds and institutional investors start investing, as well.
And then the bubble really starts to inflate in what folks talk about as the mania phase, where the media - like us - start talking about it and the public starts investing. And this, it begins with the smart money, this might be the dumb money phase, where people are investing based on the momentum and the excitement around this perceived opportunity. And then the last, which unfortunately, we're all very familiar with, which is when the bubble pops.
CORNISH: So, Professor Steve Blank, by those stages do you think we're in a bubble?
BLANK: Oh, I think we're in a bubble big-time. I think it's one of the most exciting times in Silicon Valley in the last 20 years.
CORNISH: So you're excited, but the part I remember about the four stages that Steve Henn just described, is the crash after. So, I mean tell us, what are we in for here as this, as you believe, is a tech bubble?
BLANK: Well, I think will have a crash. But unlike other bubbles, there's something unique about a technology bubble that actually is great for the country and great for innovation.
CORNISH: What is that?
BLANK: Unlike other bubbles, like financial bubbles and housing bubbles, you know, nerds don't seem to buy yachts. They seem to reinvest in their own domain. And one of the interesting phenomena about this bubble, it's based on the money that was made in the last bubble. And that's coupled with something else that's very exciting about this bubble, as well.
CORNISH: Well, before we get to that, I mean I want to go back to Steve Henn for second. I feel like we were all reporting on Pets.com and, you know, the graveyard of other tech companies that didn't survive.
BLANK: Yeah, not too long ago.
CORNISH: I mean, am I just too sensitive here to the news?
HENN: Well, maybe. You know, I think at this point at least, this enthusiasm in the technology market is different from sort of the Pets.com era. I mean, if you look at the four biggest technology companies in the country - Apple, Microsoft, Google and Amazon - three of the four have, you know, stock prices that are relatively sanely priced. And I think where we're seeing the kind of irrational excitement is at a much earlier stage.
You're seeing investors in Silicon Valley get so excited about potential opportunities that they're valuing really small, unproven companies at really crazy amounts. It's not like Pets.com where your grandmother was investing in the stock.
CORNISH: So, Professor Steve Blank, is really the difference here the fact that the public doesn't have access and can't make that bubble bigger?
BLANK: Well, there are a couple of real interesting distinctions between this bubble and the one in the turn-of-the-century. Let me say it again, I still believe we're in a bubble, but I actually think this one is good and probably much better than the last one. The last bubble, if you remember, you didn't even have to have revenue to go public. You would just have to have an e-, or Internet, or wireless or something, and people were buying it. It was a greater fool theory. And it was not only...
CORNISH: Was this just different from Instagram then?
BLANK: Yeah, and that's a great distinction. And there's two key ideas here. One is this bubble is pretty narrow. What we're seeing are inflated values for Internet apps. And the reason why is pretty spectacular. It's that for the first time, we can imagine companies having not tens of millions, not hundreds of a millions, but Facebook is approaching a billion customers - a billion people using the same application. And so, Instagram didn't have revenue but they had 30 million users in two years.
CORNISH: So, Steve Blank, you seem to be rosy, basically, about the idea of there being a bubble. But bubbles burst and that's usually a bad thing, right?
BLANK: You know, it's a bad thing if you're the greater fool at the end of the game of Musical Chairs at the...
CORNISH: Right, which is a lot of us, you know, say, if you look at the housing bubble.
BLANK: But I think we're going to look back at this decade as the beginning of an economic revolution, as is important as anything in the 16th century or in the Industrial Revolution. And it's really going to change the quality of life across the entire planet. And if that sounds like a lot for just Facebook and Instagram, you ain't seen anything yet. I think...
CORNISH: No, I get what you're saying but it's just like, is this the internal combustion engine or is this Instagram? Like, are these really things that are going to fundamentally change the way we live? Or are you just saying that these are going to build a kind of infrastructure to our economy that will be different?
BLANK: I think looking at any one of these you could laugh hysterically and say, you know, this is it. I think it's the sum of these and the amount of capital that it will return into the entrepreneurial engine. But why it's great for the country is this is how things get built. The railroads were built in a bubble. Oil was built in a bubble. But it's returned capital to something that made this country dramatically transformed and we're going to see that again.
CORNISH: So, Steve Henn, one last thing on that list of four stages, one of the stages is rationalization, right? Everyone basically saying all the reasons why this bubble is different or this bubble doesn't exist...
(SOUNDBITE OF LAUGHTER)
HENN: Yeah, that's right.
CORNISH: What do you think of that? Do you hear a lot of rationalizing going on for what's happening in the industry?
HENN: Yeah, I think you do hear a certain amount of rationalizing going on. That's not to say that these underlying technologies won't really pan-out for many people and many companies. But I think also, there will be lots of failures along the way, and lots of investors who lose money as these changes play out in our economy.
CORNISH: That's NPR technology reporter, Steve Henn. Thanks so much, Steve.
HENN: Sure thing.
CORNISH: And Professor Steve Blank, a Silicon Valley entrepreneur and now adjunct professor at Columbia Business School. Professor Blank, thank you for talking with us.
BLANK: Thank you. Transcript provided by NPR, Copyright NPR.