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Prophecy over profits

5 May 2014 By Robert Cyran

The latest mini-me internet bubble is a mere shadow of the excesses that came crashing to an end in 2000. Sure, even though the run-up may have paused, the feverish signs are unmistakable. Dozens of companies are in line to float, hubris is rampant, oddball valuation metrics abound, and revenue-free startups are still worth fortunes. Even nerd culture has somehow become hip. The latest boom is as absurd as the last, but it’s far smaller.

This year’s first quarter saw 64 companies float in the United States. That’s on track to beat the frenetic pace last year, when 222 companies raised $55 billion in initial public offerings, according to Renaissance Capital. Both those numbers were the highest since 2000.

For some, selling out to existing giants is as attractive or more so than going public. Facebook just seized messaging service WhatsApp and virtual reality startup Oculus VR for $19 billion and $2 billion, respectively. The social network didn’t even really try to justify the price tags in financial terms. And it doesn’t have to, not just because investors are inclined to believe in founder Mark Zuckerberg’s vision but because he has complete control thanks to super-voting stock.

A focus on tech prophecy, rather than profits, seems to have infected those living outside Silicon Valley too. Investors, underwriters and tech gurus are speaking in a specialized dialect of belief, peppered with ideas and phrases like MGABPPU, Hyperloop, AI singularity and super unicorns.

It’s an appealing world. The proportion of Harvard Business School graduates going into technology more than doubled over the past five years to 18 percent. There’s ready funding for their dreams. Venture capital financing in the first quarter totaled $15.6 billion globally – the highest figure since 2008, according to Preqin.

There’s an international flavor, too. Silicon Valley has always attracted ambitious engineers from around the globe. Many have returned home, fertilizing local tech clusters. A Russian venture capital firm, Digital Sky Technologies, is a big backer of private U.S. tech firms. Swedish game companies headquartered in London float in New York. And China’s Alibaba – just one exemplar of the Middle Kingdom’s own internet boom – has chosen the relatively flexible corporate governance of the United States for its expected $100 billion-plus IPO.

Yet for all the hype, this bubble pales beside its predecessor 14 years ago. The tech-heavy Nasdaq 100 Index may have reached levels last seen in 1999, but adjust for inflation and the recent high in March was still about 40 percent below its 2000 peak. In contrast, the Russell 2000 index of small capitalization companies, adjusted for inflation, is 40 percent higher now than when the Nasdaq last topped out. Tech valuations may be surging, but the sector is not even close to recovering the heft lost following the last dot-com implosion.

Six of the 10 biggest companies in the S&P 500 Index were technology firms then, versus three now. In 1999, Microsoft traded at about 80 times historic earnings and Cisco Systems at around 180 times. Today’s giants Apple and Google are valued at a relatively sober 13 and 26 times earnings, respectively. They aren’t outliers: the Nasdaq overall trades at about 20 times earnings.

One big difference is that there were actually two bubbles in the late 1990s.

The dot-com froth attracted more attention, but it was a sideshow to the far bigger telecommunications bubble. Telcos like WorldCom and GlobalCrossing went on an investment rampage, crisscrossing America with dark fiber and spending $100 billion on spectrum auctions in Europe. Companies in the sector borrowed about $2 trillion dollars globally in the five years ending in 2001 according to Thomson Reuters data.

Companies selling the gear needed for all the expected connectivity cashed in. Combined, Cisco, Juniper Networks, Lucent Technologies, JDS Uniphase and Nortel Networks were worth more than $1 trillion at the height of the boom. Once debt-laden reality intruded, the top five equipment makers lost 90 percent of their market value in fifteen months.

Fast forward to the present day, and of course valuations could crack. With startups valued on revenue multiples or website visitors, it’s safe to assume some of them won’t stand the test of time. But the hottest sectors of the market, like social networking, software as a service and companies led by entrepreneur Elon Musk are relatively small. Cisco’s market capitalization in 2000 was greater than the combined value today of Amazon, Facebook, Twitter, LinkedIn, Salesforce, Workday, Splunk, ServiceNow, NetSuite, Tesla and SolarCity.

Moreover, this round isn’t centered on expensive internet infrastructure. It’s about making use of data. That’s a far cheaper exercise, and giants like Google and Facebook have balance sheets chock full of cash, not overflowing with debt. Not only is the scale smaller, but there’s no danger of a leverage hangover. A breather in the tech stock surge might or might not herald a broader downturn. Even if it does, this time it won’t be the tech sector that causes serious damage.

Download Breakingviews’ new e-book: Tech Mania 2.014


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