Is the Next Dot-Com Bubble Bust Looming?

dotcombubbleWhen the Twitter IPO goes down, it’s expected to be valued at $11 billion. Also, Twitter loses money. Problematic?

This article from the Wall Street Journal, like many good investors out there, hedges its bets on the likelihood that a new bubble is forming. But, there’s been an increasingly large amount of rumblings from blogs and media outlets lately that the Dot-Com Bubble 2.0 is upon is – and is just about ready to burst.

Twitter is probably not the best example. While it’s true Twitter loses money now, it has an enormous user base – even a halfway decent business plan could turn Twitter into big money. Even Facebook has managed to start pulling in profits. Now, whether or not a business like Twitter that was essentially designed from the ground up to not make money can actually grow to be worthy of that $11 billion valuation, well, that’s something else entirely. But that doesn’t make a bubble.

You see the potential for a bubble when you go smaller. Pinterest, with no revenue, is put at $4 billion. Granted, still a huge user base there. But Snapchat, at over $3 billion? Now we’re running into some problems. Not only does Snapchat not make money, it hasn’t even been around long enough to be confirmed as anything but a flash in the pan. And, it’s even less clear how you would monetize something involving racy pictures that may or may not be deleted a short time after opening. The answer is always ads, but how do ads fit in with Snapchat, exactly? The fact that there are people lining up to throw money at Snapchat without even a rudimentary answer to that question is, if not alarming, at least unsettling.

The Wall Street Journal article cites that compared to the Dot-Com bust of 1999, today is looking a lot safer – on average, companies heading to IPO land are older and more established than their ’90s peers, and initial stock price jumps are much more sober than when everything went wrong in 1999. Probably the most significant number cited is that IPO tech stocks today are valued at 5.6 times sales, versus 26.5 times sales in 1999.

But, there’s a crucial difference between now and then that does not work in today’s favor. In the ’90s, a lot of the busted dot-coms had at least an idea of how they were going to make money. They were wrong, and in great numbers, but companies like Pets.com and eToys had some idea of how they were going to bring in profits. The speculation was not over whether or not these companies could find a business model, but how well those models would work.

Today’s speculation is two-fold, which becomes increasingly problematic as younger and more inexperienced start-ups are having cash lavished on them by venture capitalists. Investors are betting a) that the company can come up with a business model, and b) assuming that a) actually happens, that the company will actually be as profitable as they are hoping. This cannot happen with the sheer number of start-ups we have today. There are more failures than successes in the start-up world, and that will always be the case.

And, that’s not necessarily a problem – for now. Venture capitalists, as the WSJ article well points out, don’t really expect all, or even most of their bets to pay off. One hit can make up for several failures, and then some. A bust would require the heavy hitters going down hard – Facebook, Twitter, and the like – seems unlikely. And, even major IPOs like Zynga have fallen without huge repercussions.

What’s more likely is that we’re at a crossroads. The bubble may be just starting to inflate, and now we have to hope that investors won’t blow too hard – historically, not a great bet. The problem is, news and new companies spring up so much faster now – technology accelerates the pace of all things. That bubble could expand rapidly, especially if a relative newcomer like Snapchat were to have a successful IPO.

The other worrying part, as the WSJ points to, is smaller investors. The Jumpstart Our Business Startups Act allows less financially-endowed people to get into the investment game. This is not a good thing. There is money to be made in investing, and so investing in a tech start-up might seem like an attractive idea. And some will bet on black and hit, and be rewarded handsomely. However, as mentioned above, most wealthy venture capitalists use a shotgun approach – they have far more failures than successes. The key is, they have enough money to place enough bets that picking a few winners is virtually assured. Smaller-scale investors do not have that kind of money. They can pick a lot of start-ups and put a little bit of money into each, but that’s not apt to make very much. More likely, large numbers of people will try to pick a few and hope they get one right.

Many, I think, will be very disappointed.

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