Tech bubbles, tides and earthquakes

Don Dodge · April 24, 2011 · Short URL:

What you should know

Are we in a tech bubble? Yes. When will it burst?

I have no idea, and neither does anyone else. Mike Arrington, founder of Techcrunch, has a great story today "We're In A Terrible Blubble". It is insightful and entertaining. My view is that tech bubbles are a little like tides in the ocean, and a lot like earthquakes in California. You know they are going to happen like the cycle of tides, but like earthquakes you just don't know when.

Rich valuations for market leaders do not constitute a bubble. Bubble valuations happen when investors extrapolate the current state of growth to infinity. Or, when they extrapolate the valuation of the market leader to a tiny startup. For example, if Groupon is worth $6B, then my is worth at least 1% or $60M. Sorry, but that is not the way it works. The market leader has huge market share, higher margins, and much higher vaulation than the 2nd, 3rd, or 4th place player. Typically the top four companies in any market own 95% of the market. Everyone else fights for the remaining 5% of the market and loses; boat loads of money.

However, it is true that valuations are getting super rich, even for the market leaders. Just four months ago I wrote this;

Is there a bubble in seed stage investing? Critics point to Twitter raising $200M at a $3.7B valuation, and Facebook being valued at $35 Billion, or Groupon at $6B valuation just 6 months after raising a $135M round at a $1.35B valuation as evidence of  a bubble. The Economist seems to think there is a bubble. Eye popping headlines, but the reality of seed stage investing is very different.

Twitter, Facebook, and Groupon are not seed stage investments. These are late rounds in companies with significant traction, user bases, and revenues. Are they overvalued? Maybe. But, the best properties always look too expensive. It is only years later that those high prices look pretty reasonable. Time will tell if that is the case here.

Today, just four months later, the valuation of Twitter is said to be over $7B, doubling in just four months. Facebook valuation is somewhere around $80B, again doubling in four months. These are private companies so the public doesn't know the revenues, profits, or growth rates of these companies. Public stock markets have huge supply and demand that establish real market values. Private secondary markets are thinly traded and highly volatile. Without real market data it is impossible to say if these are bubble dreams or justified valuations.

Bubbles, tides, and earthquakes - Markets always have up and down cycles. They are in constant motion like the tides in the ocean. As soon as one bubble bursts another starts to form somewhere else. Just like the tides. But, unlike the tides, bubbles don't build and pop in predictable cycles. They are more like earthquakes. We know one will happen eventually. We study seismic data to try to predict it. But the truth is no one knows when it will pop.

One major difference between the dot com bubble of 2000 and the current situation is who will be hurt when it bursts. Back in 2000 crazy companies with minimal revenue and zero profit were going IPO on the public stock markets. Inexperienced retail investors were spending their life savings buying up these stocks. They got slaughtered. Today these companies are private. Very experienced professional investors are buying positions. When the bubble bursts these guys will get hurt, but don't cry for them. Their net worth might drop from $100M to $90M, or from $1 Billion to $900 million. Wah, wah, wah. Nobody cares. Not even the investors losing the money. They are professionals and know it is part of the process.

So, there you have it. Don't worry about a tech bubble. Take advantage of it. Start a company and build it as fast as you can. In the end investors will make millions or maybe lose some. But you will have the experience of a lifetime. Go for it!

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