Are we numb to silly valuations again?

By Shane Leonard on Feb 11, 2015

Are we numb to silly valuations again?

Originally published on 10th February at the Financial Times, as part of the FT Alphaville series. Many thanks to the team @FTAlphaville

Red ink & love affairs

It’s 15 years since Nasdaq peaked at 5,050. The economy was strong and Internet companies were replacing Industrial ones in every mutual fund. The new paradigm ruled with eyeballs and Webvans. Old money elites like Time Warner succumbed to the boyish charms of AOL.

Red ink was everywhere. But investors were in love. Insanely so.

Are we now disconnecting from reality again? If so, why are we numb to silly valuations?

Remember how silly it got?

Working for Frank Quattrone, who is still Silicon Valley’s favorite banker, I was as guilty as the next man. Imagine Valentine’s Day in 2000, when we persuaded investors to put $125 million into a UK eFinance business, Interactive Investor. It listed on Nasdaq and soared 120% on the first day. The market valued it at $1 billion. That’s $1 billion for a 4 year old company that did $4 million of sales. The offer was 26 times oversubscribed.

If you lived it, you’re probably reminiscing now: Pets.com; Webvan; Boo; Kozmo; VA Linux; Audible; and MP3.com to name a few.

History rhymes

All the signs are there again. Young businesses are dousing themselves in red ink. New VC funds with limited track records are driving up deal prices. Retail investors are looking at tech IPOs as one way bets. Enormous acquisitions are paid for with highly rated stock. And horror of horrors, stuffy old mutual funds are investing big in pre-IPO rounds.

You open the CrunchBase Daily and you start scratching your head. But you move on. Once again, you are numb to silly valuations.

So how silly has it got?

There’s no data on Uber’s latest round, so let’s look at two recent IPOs, LendingClub and Box.

LendingClub is valued at $7.5 billion versus $200 million of sales. It has just turned a profit and is growing like crazy. But a great business doesn’t always equal a great investment. The bankers’ euphemism applies, it needs to “grow into it’s valuation”.

Box is valued at $2.5 billion. That’s versus $150 million of sales in the last 9 months. It bleeds cash. It’s been spending more on marketing than it makes in sales. In its SEC filing it highlights that it does not make money on clients in the first year, and clients only become marginally profitable in year two. Yes, half of the Fortune 500 are clients, but no upgrades, no profits.

Investor amnesia

The tide hasn’t gone out yet. For now, no one cares who’s swimming without a bathing suit. It’s as if we are suffering collectively from amnesia.

The market is becoming surreal. Private equity firms are selling investments. But when they go to return the cash to their investors, the response is, dont send back the money. Please re-invest it. Roll it over, even if there is no 20%+ return on the horizon.

As Gordon Gekko said, “a fool and his money are lucky to get together in the first place”. Admit it, you know what’s coming. Even if we know not the hour.

Looking beyond the meltdown

Looking back to early 2000, tech survives. Great businesses thrive, even if their investors get burnt.

Remarkable companies rewards their investors. Google IPOed in August 2004 with a value of $23 billion. It traded at 55 times earnings and was already generating $3 billion of sales. Today’s it’s worth $350 billion. More recently, GoPro IPOed in June last year with a $3 billion value versus it’s $1 billion of sales. At the time it traded at less than 30 times earnings. Today it trades at 50 times earnings having beat forecasts every quarter.

Perhaps this is why we are numb to the silly valuations. We know there will always a market for great businesses. We may not understand today’s valuation of darlings like Uber, but we don’t care if Goldman Sach’s private clients are being foolish. We expect Uber to survive and thrive. Even if the investors in the latest rounds lose their shirts.