Dotcom the Sequel

Society was finally embracing technology into their lives. Businesses that were capable of using the Internet as a second outlet to reach a wider audience saw themselves flourishing. The values of many Internet companies double, tripled, even quadrupled in just a few years, even though many never had a quarterly profit. The belief was that massive early expansion would eventually lead to massive cash flows and profits. Investors and corporations speculated on hundreds of publicly traded companies that were at historically outrageous prices. Then in March 2000, the bubble burst, and the formula that pushed up the NASDAQ and its technology components came crashing down. Between 2000 to 2002, $5 trillion of market value disintegrated, combined with the terrorist attacks. But that was a decade ago and a painful, expensive lesson. It was sure to never happen again, or would it?

Many journalists have brought up the idea that a second technology bubble is in the works and I have to agree. Facebook, the obvious poster boy of the debate, has seen exponential growth and valuations. Goldman Sachs's investment in Facebook worth $500 million values FB at $50 billion. Others like Groupon, Living Social, Twitter, FourSquare and even Zynga (develops applications used on Facebook) have seen valuations rise as well.

A few weeks ago, Google offered to buy Groupon for $6 billion but failed after Groupon rejected the offer. Groupon later raised $950 million from private investors. Twitter raised $200 million in December 2010 alone (Blog continues below).


Of course, one significant difference that many point out are the large revenue streams and cash flow. Facebook is estimated to have earned about $1.5 billion in 2010 and earned $800 million in 2009. Twitter also has an estimated revenue of $150 million in 2010 as well, but because these companies are private, these numbers can not be confirmed.

As said, Facebook probably earned $1.5 billion in revenue, not profit, last year and is valued at around $50 billion. To put that into perspective, Dell's current market capitalization is $27.2 billion, nearly half the value of Facebook, but generated $53 billion in revenue and net income of $1.4 billion. Companies like Starbucks and Texas Instruments are also worth less than Facebook but generate at least $1 billion in net income.

Of course, Goldman is clearly paying ridiculous multiples today for big returns tomorrow. But if Facebook does go public against its will, which it most certainly will (if a company has over 500 investors in the US, it must go public), how long before current holders push the sell button? A secondary market with massive liquidity would allow investors who want to get out an opportunity to sell their shares. At 41 times revenue and probably 350 times earnings, Facebook's multiples can only be supported with rapid growth never seen. Most established companies trade at about 15 times earnings. Surely, many investors will wait a few years, but how long before one quarter disappoints?

The most Facebook can grow is twelve times. At almost 600 million active users already and a world population not yet exceeding 7 billion, in which only 2 billion use the Internet, there really is little room for expansion realistically. Not only that, based on those figures, 600 million users earns the company about $1.5 billion. That means each active user generates only $2.50 annually, which sounds right, since I have never paid for anything on Facebook. Starbucks needs to sell just one beverage to match Facebook's awesome earnings power.

To be honest, I have very little experience with venture capitalism and do not find speculative buying combined with buy-and-hold a way to make money, but at these crazy valuations on Facebook and many other media sites, I'm confident in saying that I would never buy a Facebook IPO except to day trade it. Only time will tell how correct we all are though.