This period could be remembered as the inflection point of Tech Bubble 2.0.
And while this bubble is outside the view of most investors, since it’s happening in private investments rather than the public markets, but it’s a bubble just the same.
In short, we’re seeing money flow to technology startups (and web-based companies, in particular) at rates not seen since the 2001 tech bubble.
Take Rovio, for example. In a deal last week, the maker of the popular mobile device game, Angry Birds, announced a round of financing worth $42 million.
Most disturbing, this round of financing from venture capital firms Accel Partners and Atomico Ventures is a so-called “Series A” type. This means it’s very early stage financing, totaling somewhere around $2 million to $10 million.
A deal this size is almost unheard of, particularly for a company with a game that only sells for a few bucks a pop. Yes, it’s popular – Rovio has made a substantial amount from two million Angry Birds’ toy sales and other merchandise – but the company made 52 other games before it that were essentially run-of-the-mill.
However, it’s just one part of the venture capital frenzy driving the valuations of web companies to crazy-high levels.
Popularity Without Profits
For example, Facebook is valued at $75 billion, while Twitter just closed a deal the values it at $10 billion.
Based on traditional metrics that include “outdated” concepts like revenue and earnings, those values are too high. Still, tech loyalists justify these valuations based on the size of Facebook and Twitter’s user base and high barriers to entry into the market.
However, once you get to the “second tier” of web companies, the amounts being invested in these companies just doesn’t add up…
Two More Pie-in-the-Sky Private Equity Deals
Like Rovio, the deals last week show capital flowing to companies that face a steep hill to profitability.
~ Box.net: The Wall Street Journal just included a quick profile of box.net – a website that offers free online storage up to a certain amount, then charges a fee. The 140-employee business just raised $48 million from a group of venture capitalists.
My issue? The company competes with dozens of websites that essentially have the same business model. Anyone with a few engineers and cash to rent storage on a data server can start another competing service. And the leader of this particular niche, Dropbox, has perfected the user-interface for storing files. I don’t see where box.net could go from here.
~ StumbleUpon: The company recently raised $17 million, despite the fact that it doesn’t have a business model. As an add-in to your browser, it sends to you a random website that may pique your interest. You then tell StumbleUpon whether or not you like the website and it incorporates that into its recommendations. Eventually, you’re bouncing around all over the web discovering all kinds of sites.
Even eBay (Nasdaq: EBAY) knows StumbleUpon is flawed. It bought the company in 2007, only to spit it out again in 2009 after being unable to capitalize on the company’s sizeable user base.
This is One Party You Don’t Want to Attend
Maybe I’m too focused on the bottom line here. But I just don’t see a business model in most of these applications… even though I love to use them.
The good thing is that individual investors aren’t a part of the venture capital markets – and thus don’t have the risk. Because imagine how high valuations would soar if the speculative public took over for venture capital professionals.
If this bubble doesn’t pop soon, some of these web companies will reach the IPO stage, thus opening the doors for any investor to join in. Tread carefully. While these tech darlings may rise initially – and OpenTable (Nasdaq: OPEN) is a good example here – it’s folly to believe you’ll know the right time to sell.
In this case, though, it looks like even the professionals are going to take significant losses when investors again lose interest in companies that can’t make money.
Ahead of the tape,