Inflated Tech Valuations Bloat The Entire Economy

http://www.forbes.com/sites/rogerkay/2014/04/22/inflated-tech-valuations-bloat-the-entire-economy/

by dmbaggett • 12 years ago

37 45 12 years ago

ChuckMcM7• 12 years ago

Heh, when ever I read these I think "So why do they care?"

It reads as yet another "I don't understand so it must be {wrong | criminal | crazy | bad | what-have-you }" kind of rant. Fair enough, but focus on the 'don't get it' part not the conclusion based on non-understanding part.

If company A's stock is 100x over valued, and they buy Company B with it for 100x more than Company B is "worth" has that changed anything really?

In the dot com bubble there was a serious problem, individual retail investors who had no idea how to value a company were buying stock in those companies at what ever price the market set. The market kept raising the price and the retail investors kept pouring in money. A seriously large transfer of wealth from people who didn't understand to people who took advantage of that. Once they were no longer willing to do that, poof the market makers took their money out and left. Boom!

As long as the folks doing the buying and selling are using their own money, why should anyone get upset if they are "over paying" ? When people ask me if they should invest in tech companies I tell them no. They should invest in index funds, they are low load, maximally diverse, and resilient. So billionaires are out competing with each other to buy companies, sit back, grab a bowl of popcorn and watch the show. But why get emotional over it?

JonFish85• 12 years ago

I'm not in finance, so this is just my uninformed opinion.

I imagine it's at least partially because this does affect everyday people, even if they're not directly investing their own money. People's 401ks & pension funds are likely wrapped up in these (at least partially). Even if you have an index fund, say tracking the NASDAQ, these huge valuations are propping it up (in the FB case).

And as long as the valuations stay high, things are great. But if/when it declines and suddenly money evaporates, it can really hurt if you're depending on it for retirement / college / whatever. Even the indirect parts of it.

ChuckMcM7• 12 years ago

The point of index funds is they change their composition when things go south, the S&P 500 index went from 447 in the early 90s to over 1800 today. If you're investing $50/month in that you did quite well.

marincounty• 12 years ago

Yea, It does matter. As to 401's and pensions; I hope pension managers are getting out of tech stocks like Facebook, and Twitter--just until the bubble bursts. I hope some of the Bubble Boys who make billions on naive, greedy, and professional hedge fund managers help out the millions of Americans who will be close to homeless when it does burst? Do I hold them accountable--kind of--just because of quantitative easing. And the Bubble Boys must know they really don't have the companies they claim. I know I just use FB for posting, and never used my real name. I did reserve my real name because I thought one day it might be useful, but never use the site like FB thinks I do.

dmbaggett• 12 years ago

The point of the piece is that one should care because it can affect the broader economy, including lots of people who didn't personally take on any tech-company-bubble risk. Sort of like when banks overpay for, say, mortgage-backed securities. Obviously you can disagree with the piece, but it is literally attempting to answer the question you're posing rhetorically here.

ChuckMcM7• 12 years ago

This is the entire argument of the piece:

"When he [company CEO] doesn’t [make the valuation call], bankers and lawyers run the show. Valuations are derived from spreadsheets: some figure times earnings before interest, taxes, depreciation, and amortization (EBITDA), down to five significant figures. Never mind that many of the assumptions are bogus. The lawyers and bankers argue with the target, fudging the assumptions back and forth. But these valuations are at least tacked to something in the mortal realm."

"When the UMaster does care, the deal is just a made up number that he pulls out of his, er, pocket. All caution is thrown to the wind, and the bankers and lawyers scramble to back-fit the spreadsheets and assumptions after the fact. The back-fitting occurs because everyone needs to be covered. Everyone except the big guy, that is."

The author's argument is that the CEO of a company is incapable of making a reasoned value judgement about the "value" of a potential acquisition.

In my opinion, what he is actually saying is "I don't understand how these guys see value, it must be incompetence." And yet, somehow, the previous "stupid" valuation (of Instagram) seems to have paid off for Facebook, not only that but they are slowly and inexorably eating into Google's tender search advertising flank. How do you value that? How does Mark Zuckerberg?

So does the article really answer any question? That too is an interesting way to analyze it.

He claims it in the title, gives an actual (non-Tech) mechanism (quantitative easing and near zero interest rates that are known causes of inflation), and then rambles a lot about how he doesn't get the valuations being thrown around, labels those valuations as inflationary, and then backs off and hedges like crazy with "With billionaires now as thick as blackberries (the fruit), this type of overvaluation can’t be good for the rest of the economy. Only time will tell whether these fat birds come home to roost and we find ourselves buying chicken at $500 a pound."

Except that it is expected that $500 a pound chicken will come about as a result of pumping a bunch of money into the economy, so how much of that can be laid at the feet of a tech company acquisition? How about even a smidgen of a hint as to how he might separate out the impact of his two "causes" ?

As you can guess I think the complete article is, as I summed it up as, "I don't get how they got these values, they must be wrong or bad or both." and while I sympathize with his lack of comprehension, I never understood how lending money to people without a way to pay it back, to buy houses even passed the sniff test, I could give you some reasoning as to why I thought it was a bad idea.

Clearly you read it differently, help me understand your reading of how it can effect the broader economy?

pkaye• 12 years ago

Are you old enough to remember the dot com bubble and bust?

ChuckMcM7• 12 years ago

Heh, I joined Sun Microsystems as an engineer on the Monday after they went public in 1986 :-)

notacoward2• 12 years ago

Sadly, the lesson some people learned is not that they were part of something FUBAR. Rather, it's more like "get in earlier next time and hand off to some other sucker before reality sets in"

notacoward2• 12 years ago

#1: opportunity cost. When all of the incentive is to create paper value, many people who might otherwise have created real value don't. Since our whole economy depends on someone creating real value, that creates risk even for people who weren't party to the transaction.

#2: their money? Facebook didn't invent money. They got it by making promises to large investors and banks, who in turn got it by making promises to small fry. If 90% of the people whose retirement money went into WhatsApp don't believe that's a reasonable decision and wouldn't have condoned it if they'd had any choice, somebody got defrauded. It doesn't matter whether it was a series of little deceptions or delusions instead of one big one. The people who will be left holding the bag most certainly do have the right to sound warnings and issue complaints.

buckbova• 12 years ago

There’s no way Oculus VR is worth anything like the $2 billion that Facebook is offering for it. The company has no revenue, no product on the market, and an unproven technology.

Many keep repeating "there is no bubble", but it is hard for me to believe. The party has to end sometime.

rjtavares• 12 years ago

Oculus really is the wrong company to use to prove we're in a bubble. By most accounts, it's the first good implementation of a technology that we know is going to be huge in the future (see every scifi world ever). Of course it's a risky investment, but the potential payoff is undeniably huge

berberous• 12 years ago

I don't necessarily disagree, but of all the high valuations these days, Oculus strikes me as one of the least offensive. Nearly everyone who has used it has described it as potentially revolutionary. They have a huge lead on competitors, and I'm guessing they may have some patents on key innovations.

Whereas, companies like Snapchat...

lbrandy• 12 years ago

This statement contains no information.

Yes, at some point between now and the heat death of the universe, the stock prices of technology companies is very likely to go down. This is not only information-free, it's also not a contrarian opinion.

Zigurd2• 12 years ago

Sure, the party will end, but how the heck is that going to turn into consumer goods inflation? What "trust" is he ranting about? How is AirBnB going to make chicken unaffordable?

pachydermic• 12 years ago

Oculus does have a real, physical, available product - I've used one personally that my friend bought (albeit through the kickstarter page). There are definitely people who are interested and it actually worked relatively well. Maybe it won't catch on, but I don't think it's absurd like many other tech start ups.

Plus, they weren't bought for $2 billion. They were bought for $400 million in cash and the $1.6 billion in FB stock which is quite a different thing. If you believe that FB is overpriced, then they were really bought for a lot less than $2 billion.

wcummings2• 12 years ago

What does the product being physical have to do with its value?

scotty792• 12 years ago

There's no bubble, just way to much money floating around and nothing interesting to buy. Supply of money vastly exceeds the amount of worthy investment vessels. An if you can get a good return at least get lousy return (or none at all) with very small chance of getting awesome return. What are you going to do with your bazzillion dollars? Buy a hotel chain? Another one? Give me a break!

cliftonk• 12 years ago

The party won't end until interest rates return to natural levels. Until then you're going to have a tremendous amount of volatility and a market continuing to grow faster than GDP.

cma• 12 years ago

He's wrong about Oculus having no revenue: they've sold about $27million in Dev kits and DK2 pre-orders. The writer suggests a valuation of $20million, but didn't even do any research.

What he says at the beginning about the reason inflation is low despite low interest rates being a game of trust is pretty odd-ball as well.

One thing thing that is inflated is Forbes-blogger pagerank, due to Forbes smothering a bunch of crappy blogs in pools of their magazine operation's pagerank.

(I think the Oculus valuation might be high because I don't know of any exclusive patents, etc. they hold. But, both the Anderssen round of investment and the Facebook buyout were supposedly in response to a prototype that hasn't been revealed yet. If they have integrated foveated rendering in a proprietary way, etc. they could take a huge lead as VR explodes)

Zigurd2• 12 years ago

That was an astoundingly bad article, even for a pop-business publication. There are a lot of things going wrong with the economy but a danger of tech valuations igniting inflation, apart from Bay Area housing, is not one of them.

venomsnake• 12 years ago

Very Serious People need to find another way to threaten us with hyperinflation after their warnings for the last 5-ish years failed miserably.

So they take a real issue - a (very) plausible .com 2.0 in the works and spin it to their favorite topic.

Potential tech crash won't be good for the economy at all, but it will inflict damage by other mechanisms.

nutjob123• 12 years ago

This guy is just showing off his ignorance. Really no analysis went into this piece.

ryen• 12 years ago

Sure, its mostly opinion. But the paragraph starting with "Facebook’s two-year chart shows that..." has substance.

Eliezer• 12 years ago

The opening comments about the Federal Reserve trying to inflate US debt out of existence caused me to stop reading, as it was immediately obvious that the author didn't understand economics.

fsk• 12 years ago

In a paper monetary system, you can have unlimited national debt. It's just a number. The US Federal Government is the issuer for dollars, and its debt is denominated in dollars. So, they can always print more money/bonds to refinance the debt. (Unlike Euro countries, where their debt is in Euros but no single country controls the Euro.)

When their is inflation, existing debt is worth less, because it can be repaid with inflated dollars.

Right now, the Fed Funds Rate is 0.25%, while real inflation is much higher than that. (The CPI is a lie.) That creates a perverse incentive, where (due to the financialization of the economy), it's profitable to load up on debt, buy tangible assets, then wait for inflation and repay the debt with inflated money.

There is no limit to the amount of the US Federal government debt. There is a risk that Congress could refuse to raise the debt ceiling. More national debt causes more inflation. If inflation is too high, there is the risk of a hyperinflation collapse of the monetary system. Until that point is reached, there is no limit to the national debt.

pessimizer• 12 years ago

Unless you have some evidence that CPI is a lie, it's important to mention that the idea that increasing the money supply must lead to inflation is completely counterfactual. We have massively increased the money supply. Inflation is still too low, rather than too high.

http://www.tradingeconomics.com/united-states/inflation-cpi

scotty792• 12 years ago

Newsweek describes all the things Facebook could have bought with that money other than a messaging platform. Things like a passel of double-decker Airbus A380s, an aircraft carrier, or vaccinations for every child in the world.

You don't know how much 12bln$ worth of Facebook stock is worth until you try to sell it.

alanlewis• 12 years ago

Mark Andreesson, Chris Dixon, and Benedict Evans discuss tech valuations on the most recent A16Z podcast: http://a16z.com/2014/04/21/a16z-podcast-evaluating-valuation...

(Spoiler alert - none of them think there is a tech bubble, at least not broadly)

general_failure• 12 years ago

It's in their best interest to say that this is not a tech bubble. Just saying.

jonas21• 12 years ago

Funny that the author uses the YouTube acquisition as an example of one that "justifies a high valuation by eventually paying out".

Back in 2006, it was a company with very little revenue that was under threat of being sued out of existence by copyright holders -- arguably a worse place to be than a lot of the more recent acquisitions he's taking issue with.

poopsintub• 12 years ago

The author doesn't understand much imo. He compares a hotel chain with a limited number of properties, hotels, and exponential growth, to airbnb, which can blast past the number of booked nights of said old hotel in as little as a few months or years. The valuation is very high because it has proven it has the ability to take on the whole industry, not just one chain.

leccine• 12 years ago

How about bashing the bing banks fueled real-estate boom instead?

RV86• 12 years ago

Inflated Tech valuations are the least of our economy's problems. This article is riding the wave of anti-tech sentiment in an otherwise stagnant, slow-to-recover economy. It's click-baiting and we're all reinforcing this sort of thing by being agitated by it/drawn to it.

Add up all the "bloated" Tech Valuations and you don't get anywhere close to the 1 Trillion+ we're looking at in outstanding student loans and the effects the bubble bursting might have on creditors and debtors alike.

I'd enumerate other much more dangerous threats to our economy, but I just read on Secret that someone is about to acquire my company for 5B.

jdkuepper• 12 years ago

Let's look at it another way.

You own a company that's trading with a P/E of 100x. Investors expect a lofty growth rate to justify that multiple and organic growth only lasts for so long as a market leader. In finance, price-earnings to growth ("PEG") ratios tend to be 1.0 at fair value, meaning a 100x P/E means investor expect 100% annual growth. Your high valuation makes acquisitions easier (assuming your overvalued now, you are buying assets at a discount). And, those acquisitions are perhaps the only way to achieve/maintain those lofty growth rates over the long-term. So, what's stopping you from making those acquisitions when others are in the same boat?

Inflated Tech Valuations Bloat The Entire Economy

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