A Non-Tech Person's Guide To The Tech Bubble—And Why There ISN'T A Tech Bubble


Photo: Flickr/Clearly Ambiguous

A lot of people seem convinced that we’re in a tech bubble, and since Facebook bought Instagram for $1 billion, that idea has broken into the mainstream. The reality is we’re not in a tech bubble. As an analyst with Business Insider Intelligence, Business Insider’s internet market research service, I spend all day analysing tech companies, markets and trends. Here I’ll  explain for a non-tech audience what’s going on, and why there’s no bubble.

Buzzfeed did a very good “Human’s guide to the tech bubble” post where they argue for a non-tech audience that we’re in a tech bubble, as an FAQ. So I’ll do the opposite here. Here’s a human’s guide to the tech non-bubble.

First of all, what’s a bubble?
Glad you asked. Before we can decide whether there’s a tech bubble, we have to ask what a bubble is. And the important thing to get is that a bubble is a mass delusion. Technology investor and visionary Peter Thiel has a good definition which boils down to this: a bubble is a) a widespread, intense belief that’s b) wrong.

In other words, a bubble is what happens when the vast majority of people believe (and are putting their money into) things based on a fundamentally wrong-headed notion.

Ok, so how do you know we’re not a bubble?

the economist tech bubble debateIf everyone thinks it’s a bubble, it’s not a bubble

Photo: The Economist

The very easy way to know that we’re not in a bubble is that everyone thinks we’re in a bubble.When The Economist put on a debate on “This house believes that we are in a new tech bubble”, the “Yes” side won by 69%. It wasn’t even close. The “No” side never broke 35% throughout the debate.

If everyone thinks we’re in a bubble, it’s not a bubble, since a bubble is a mass delusion. 

C’mon. You gotta give me better than that. Give me some facts and figures!

stock market peThe technology sector is not valued very highly

Photo: Yahoo Finance

Facts and figures? Fair enough. A very easy way to know whether we’re in a tech bubble or not is to look at the valuations in the technology sector. That’s almost a tautology: if we’re in a tech bubble, technology company valuations should be high. The valuation of a company is how much investors think that company is worth: investors buy and sell company stock, and the price they pay for the stock tells you how much the company is worth. (The price of one share multiplied by the number of shares outstanding is the value of the company.)

And the thing to note is that technology company valuations are at historic lows.

One good measure of valuation is the price-to-earnings ratio, or P/E ratio: the value of the company divided by its earnings, or how much money it makes after it pays for its costs. P/E is a good measure of valuation because P/E tells you how much investors expect the company to grow in the future. (This is because what an asset is worth is, in theory at least, the “net present value of its future cash flows”, or how much you’re paying now for the money it’s going to make in the future. So the higher the P/E ratio, the more money you expect the company to make in the future.)

Office supplies are valued higher than the internet.

So, how high is the P/E ratio for the technology sector? As tech investor Chris Dixon points out, the market-cap weighted P/E ratio for the technology sector is 17

How high is 17? It’s pretty low. 

For comparison, the P/E of the S&P 500, which is an index of the 500 biggest companies in the US (if they’re the biggest companies, you’d expect them not to grow very much, and remember, P/E is a measure of expected growth) is 14.

The P/E of the consumer goods sector is almost 22. In other words, the market is saying that they think a sector which includes office supplies and shaving cream is going to grow faster than a sector which includes Google, Apple, LinkedIn, Salesforce and so on. That’s the definition of NOT a tech bubble.

Let’s go further compare the biggest technology companies in the world, in 1999 and today. 

Today the biggest technology company in the world is Apple. What’s its P/E? 14. 14! The same as the whole S&P 500! Remember, P/E is a measure of expected growth. And Apple grew profits (profits, not revenue or eyeballs) by 94%. It almost doubled profits! Meanwhile the S&P grew earnings by…wait for it…about 5%. And the market is saying it’s expecting them to grow at about the same rate. So again, the OPPOSITE of a tech bubble. 

I’ve shown this in the chart below (via Ycharts), showing how as Apple’s earnings (trailing-twelve-months) grew, its P/E (which is a measure of expected growth, remember) shrank. That’s the opposite of a bubble. Even absent a bubble, you’d expect investors to expect more growth as it materialises, but the opposite happened. Apple is nearly doubling profits every year and yet investors are saying it’s going to grow like a stodgy old company.

apple pe vs earnings ttm

Photo: via YCharts

How does that compare to 1999? In 1999 the biggest technology company in the world was Microsoft, and its P/E was… almost 60. So more than 3 times higher than the technology sector as a whole today, and more than FOUR times higher than its equivalent biggest-tech-company today, Apple. 

Clearly, clearly not a bubble. 

Ok, so maybe the bubble isn’t affecting the big companies yet, but what about those huge IPOs for profit-less companies? Isn’t that very 1999? 

Groupon IPOA bubble?


First of all, remember what we wrote above: a bubble is a MASS delusion. It’s not the same thing as some things being overvalued or some crazy things happening. For there to be a bubble EVERYTHING has to be overvalued. If you look at the real estate bubble, some markets were clearly more crazy (California, Florida, Nevada) but ALL markets were overvalued. If you look at the late 90s tech bubble, tech was clearly crazily overvalued, but the entire stock market, and indeed the entire economy, went into overdrive. 

case shiller nationalDuring the real estate bubble, things went crazy EVERYWHERE, not just a few places

Photo: FRED

So people are moving the goalposts here: they’re defining “bubble” as “not a bubble” to say that there’s a bubble when the evidence says that there’s not a bubble. But since that meme won’t die (and remember, that itself evidence that we’re not in a bubble) let’s dig into it. What’s going on with tech IPOs? What’s going on is that in 2011, finally, after a decade of a tech IPO nuclear winter, we got some technology IPOs. Which got plenty of people to cry bubble.

There are two reasons why people think this might be sign of a bubble:

  • Plenty of these companies’ stock tended to POP by huge amounts on the day of their IPO, which is something that happened in the tech bubble. 
  • Plenty of these companies don’t show profits. 

So, whats the deal with first-day pops? 

Amazon Stock After IPOAfter Amazon’s IPO, the stock fell, breaking the IPO price. Then it took off.

First-day pops can happen for lots of reasons. The problem with any IPO is that the bankers who run the IPO have to evaluate investor demand for the stock and then “price” the stock at price that they think will match supply and demand (actually a little lower than that to entice institutions to buy the stock at the IPO instead of waiting). But it’s more art than science. Henry Blodget wrote a great post on how this happened with the LinkedIn IPO, which popped a crazy 90%.But the thing is, IPO pops don’t equate to bubbles. A great example, as Henry Blodget also points out, is the Amazon IPO. Amazon was for a long time the poster child for the tech bubble (experiencing both the glorification and the backlash), and it went public in 1998, so after the bubble started inflating in 1995. Surely it had an incredible pop? No, the opposite thing happened. Amazon increased its IPO price, and after it went public the stock fell—and then it took off again, because it really was a bubble.

The point is, you can have pops without a bubble, and you can even have a bubble and no-pops. The correlation isn’t 1:1. Pops were a feature of the tech bubble, but by themselves pops don’t tell you whether there’s a bubble or not. So if you think pops show there’s a bubble, you’re wrong. 

But still, many of those companies that are going public aren’t profitable? Surely that’s a problem?
This is how crazy we’ve become, and this is how obvious it is that we’re not in a bubble, that people think there’s something inherently wrong with an unprofitable company going public. What are stock markets for? They are for financing companies. That’s what they’re for! That’s their function.

The REASON we have a stock market is to have an efficient way to provide financing for companies that NEED it. 

By definition, if stock markets exist to provide financing for companies that need financing, then some of those companies are going to be unprofitable. Plenty of profitable companies need equity financing too, of course, but if you’re inventing a mechanism to finance companies that need financing, some of those companies are going to be unprofitable.

It shows how badly we are still scarred by the dotcom bubble, when unprofitable and worthless companies were floated, that we think there’s somehow something inherently wrong with unprofitable companies going public. And that we are so scarred by the dotcom bubble itself shows that we’re not in a bubble, that we can’t be in a bubble, because we keep fighting the last war. We’re like Vietnam war vets, constantly having flashbacks.

Now that’s just crazy talk. Plenty of these companies are going to zero!
You know what? MAYBE!

Almost all of the big tech IPOs of the year are down—not a bubble.

So what? Again, that’s what a market is. Some companies fail. Some companies get overvalued. Some companies get undervalued. Some become profitable, some don’t. The fact that unprofitable companies exist, and that some go public, doesn’t mean we’re in a bubble. It means that we live on Planet Earth.

It would be a bubble if plenty of companies with absolutely no business, as well as the big companies, were shooting to the moon. But that’s not what’s happening. At all.

Come on now, plenty of these companies are way overvalued. Bubble bubble!
Ok, let’s look at what happened with this year’s big tech IPOs. Here’s what it looks like:

tech bubbleAlmost every big tech IPO is down. Clearly we’re in a bubble.

Photo: Google Finance

OMG BUBBLE! Almost everyone is down. 

End of discussion.

Nuh-huh! Some of these companies are still overvalued! You were talking about how tech companies’ P/E ratio is low. LinkedIn’s P/E is 905!! BUBBLE!
Yeah, so what?

You can’t be serious.
No, I am—so what?

Again, go back to the beginning of our conversation. A tech bubble is a mass delusion which causes everything to be overvalued. That’s clearly not what’s going on here.

Are some tech companies overvalued? Yeah, probably. 

You know what else is overvalued? Well, statistically, 50% of everything. That’s how markets work. People place bets on the future. Some of those bets don’t pan out. Sometimes, it turns out something was overvalued, and sometimes it turns out another thing was undervalued. Apple’s P/E of 14 probably screams “undervalued”; LinkedIn’s P/E of 905 probably screams “overvalued”. What those two data points put together scream is, “not a bubble.”

(I should also point out that LinkedIn is profitable, has been beating analyst estimates, has a highly defensible business with network effects, diversified revenue streams and is growing very fast in very large markets, and also that LinkedIn is in investment mode, which means that its P/E ratio is not very meaningful, because earnings are squeezed.)

This isn’t true just in the tech sector. If you follow biotech, every other day a biotech company gets a drug approved/not approved by the FDA, which causes the stock to soar/crash. Turns out it was under/overvalued. The price of oil goes up and down based on what investors think supply and demand are like. On any given day, it’s probably undervalued or overvalued. That’s what markets do. That’s how they work. The fact that some tech companies are probably overvalued doesn’t mean we’re in a bubble. It means we’re on Planet Earth.

Ok, ok, fine. Let’s forget about public tech companies. This time, it’s not a public company bubble, it’s a bubble in STARTUPS. THAT’s where the valuations are crazy, in Silicon Valley!

chart of the day, startups cost per user, april 2012On a per-user-valuation basis, Instagram is FAR from a bubble

Again, if the bubble is limited to Silicon Valley, it’s not a bubble, because what you have isn’t a mass delusion. But, again, let’s keep digging. It’s hard to get data, because private company valuations are, well, private. What’s more, there’s going to be a bias, because the valuations that get reported are the big ones, because these are the ones that get leaked to the press and that get people’s attention. So everyone went nuts when Facebook bought pre-revenue Instagram for $1 billion, but no one talked about, for example, Intuit buying Demandforce for a very not-bubble-like 7X revenues.

(And the reaction itself was telling: I argued the Instagram deal totally made sense and got slaughtered in the comments; meanwhile Jon Stewart, who groks the zeitgeist like nobody, thought it was ridiculous and sign of a bubble.)

“Many good companies are having trouble raising Series As”

One person who has a good eagle’s-eye view of the situation is Chris Dixon, who is one of the top angel investors in the world and is a partner with a very active seed fund, Founder Collective. He weighed in on the bubble question. You should read his entire post, but here are the key points: 

Certain stages of venture valuations do seem on average over-valued, in particular seed-stage valuations and (less obviously) later-stage “momentum valuations.” […] Certain stages – most notably the Series A – seem under valued. Many good companies are having trouble raising Series As and the valuations I’ve seen for the ones who do have been pretty reasonable. […] The argument that sometimes startups get better valuations without revenue is somewhat true.

Aha! So plenty of companies are over-valued! No-revenue startups get better valuations! Bubble!
Again, no. What Dixon is saying is that while some things look over-valued on average, other things look under-valued on average. As I explained above, this means that we’re not in a bubble, since some things being over-valued and other things being under-valued is by definition a market, not a bubble. 

But people like Chris Dixon are biased. I read in the New York Times that investors like him are talking up valuations so they can cash in. 
Ok, so this is a new thing that people are saying and it’s worth digging into, because it’s really weird.

Respected Times reporter Nick Bilton wrote in a much-discussed recent story that when investors tell him there’s no bubble it’s “spin” because if they acknowledged there’s a bubble, the bubble would pop. (Nevermind that, as we saw, everyone is screaming that there’s a bubble.)

Another tech pundit, Anil Dash, has been saying something similar: it’s only people who are in the industry and who have a vested interest in how the industry works, who are saying it’s not a bubble, so they’re either deluded or misleading people. 

This idea is all sorts of wrong for two pretty important reasons:

  • It dispenses the bubble people from engaging people who have actual expertise in the topic. When Dash says people “already invested in how the tech industry works today” have the wrong perspectives, he’s essentially saying, “if you know what’s going on in the tech industry, your perspective on the tech industry must be wrong.” That’s really weird. You should always stay aware of people’s biases of course, but a guy like Chris Dixon simply knows more about tech valuations than 99% of the people weighing in on his question (including me). Dismissing him for that reason seems crazy. The only person Bilton interviews in his story is a man named Paul Kedrosky, who is known for constantly shouting bubble. 
  • Investors also get accused of holding valuations down! This is prima facie evidence that this idea that biased investors are hyping up valuations is wrong, or at least highly questionable. Investors buy as well as sell tech companies (or tech company shares). So their incentives go in both directions: they want to sell high, obviously, but they also want to buy low. And investors are loudly, and constantly bitching about high valuations! Here’s superstar VC Fred Wilson. Here’s Mark Suster, another VC. Remember that whole saga called AngelGate? Last year Michael Arrington of TechCrunch accused the top Silicon Valley angel investors of illegally colluding to keep down tech startup valuations. In the end he couldn’t prove it, but the idea of investors doing everything to keep valuations down, not up, made sense to everyone. So it’s pretty weird to accuse people who are constantly saying valuations are too high of spinning up valuations.

But the absurd circularity of this logic is what makes it so appealing to the bubble people. As Buzzfeed writes, anybody who argues against the existence of a bubble is by definition wrong and deluded because “nobody wants to admit to being part of a bubble.” It’s like a conspiracy theory: evidence against the theory is actually evidence of how pervasive the conspiracy is. 

(Buzzfeed’s John Herman writes that “nobody can give a straight answer” to the bubble question. How’s “No, no, hell no, not a chance, no.”?)

All right, now you’re just throwing up tons of red herrings, which is how I know you’re wrong. I’ll grant you that this bubble is different, as Buzzfeed says, but what you’re missing is that there’s clearly something wrong when no-revenue startup are getting inflated valuations. 
colour raising $40 million! Instagram getting bought for $1 billion! Instagrams-for-video raising money at hundreds of millions of dollars! Evernote at $1 billion! Dropbox at $5 billion! You gotta admit that there’s something at least bubble-LIKE going on here. Maybe a smaller bubble, or just the start of a bubble, but we’re in bubble territory! 
Now we’re talking! But nope, you’re still totally wrong!

(And still defining “bubble” to mean something it doesn’t mean.)

Oh come ON. Startups with NO REVENUE can’t be worth HUNDREDS OF MILLIONS of dollars, or A BILLION DOLLARS! That’s just a fact! BUBBBLEEEEE!


Photo: Flickr/The Big Quack

This no-revenues thing is actually a very important point, because it’s totally wrong, and it’s worth getting into the weeds of the many, many reasons why it’s wrong. So bear with me, here. FIRST CRUCIAL POINT:

This is Finance 101: the value of an asset is the net present value of its future cash flows.

People who think tech companies are overvalued are always talking about “fundamentals” and how tech companies don’t get valued according to “fundamentals” and this is how you get into bubble territory. 

But they’re completely overlooking a fundamental law of finance, which is that the value of an asset is the net present value of its future cashflows. 

What does that mean? Well, in theory at least, the “fundamental” value of any asset, including a company, is the value of all the money it’s going to make (after paying expenses), discounted to today. And that theory is important because—as the bubble people never tire of pointing out—the actual value of an asset tends to gravitate (or rise) toward its “fundamental” value.

“Discounting” accounts for the fact that a dollar today is worth more than a dollar tomorrow, and so you “discount” the value of the future dollars the asset is going to throw off to what they’re worth today. 

There’s a fair bit of maths involved with making it work in practice, but the key point is this: what any asset, including any company is worth, is based on its expected FUTURE cash flows. That’s a fundamental law of finance. 

Every valuation is based on future cash flows.

Therefore, whether a company makes no revenue, or little revenue, profits, or no profits, that only matters to its valuation insofar as it tells you what FUTURE cash flow is going to be. 

That has two consequences:

  • Number one, valuation is more art than science, because it’s impossible to predict the future. That means that plenty, if not all, valuations, are wrong. That’s why we have markets: plenty of investors come together, they buy and sell (or don’t buy) based on their different views of what the future earnings of a company are going to be, and that gives you an answer. Plenty of things get overvalued. It doesn’t mean we’re in a bubble.
  • Number two, there is nothing INTRINSICALLY wrong with a no-revenue, or no-profits company being worth lots and lots of money. Plenty of companies with “real” cashflows and profits end up being worth nothing—ask the fine people at Kodak, Bear Stearns, Lehman Brothers, AIG and General Motors. And plenty of companies that are losing money by the bucketful end up throwing off tons off cash—ask Apple (nearly bankrupt in the 90s), and Google, and Amazon, and Facebook, which may or may not be overvalued, but did earn a billion dollars in profits last year after many people said it would never make money. 

And again, it’s one of the fundamental laws of finance that tells you this, not weird eyeballs-and-clicks dotcom economics. 

It’s fundamental that people understand this. Don’t get me wrong: it doesn’t mean that all no-revenue startups are worth billions of dollars. It’s clearly possible for a no-revenue startup to get overvalued, as Chris Dixon has written. But what it DOES tell you is that, by itself, “no revenues” or “no profits”, doesn’t tell you whether a company is worth money or not. You have to look at the SPECIFICS of the company—its economics, its technology, its market, its usage and so on—to know whether it’s worth something or not, and how much it’s worth. And there’s plenty of room for disagreement in that! People will get it wrong! But, again, pre-revenue startups getting valuations with tons of zeros is not, by itself, indicative of a bubble. 


In consumer internet, usage almost always precedes profits.

In business in general, and in consumer internet in particular, usage almost always precedes profits. 

This is the second reason why the no-revenue-equals-no-worth line is so frustrating, and so desperately wrong. 

First of all, almost every single successful business starts out unprofitable. Internet or no. That’s how it works. You invest money to build a product or buy inventory to sell later on, or what have you. Hopefully you recoup your investment and end up making money (if you don’t you go bankrupt), but that’s almost always the case. Unless you find customers who are willing to pay you in advance or something, every single business starts out unprofitable.

(Case in point: Sarah Blakely made waves when she became the youngest female self-made Forbes billionaire this year with her Spanx company. Her company was “profitable from the start”, but that’s only true from a technical, legal standpoint: before she started the company, she invested tons of man-hours building her product. From an economic standpoint, Spanx was unprofitable before it was profitable.) 

So first of all, businesses in general start out unprofitable.

But this is particularly true of internet businesses, and especially consumer web businesses. It’s just how it is. 

Every single successful tech company (…) started out with eyeballs and clicks and only later became profitable.

Every single successful tech company in the world (that I’m aware of) started out with eyeballs and clicks and only later became profitable. Yahoo. Google. Amazon. eBay. Salesforce. Baidu. Huffington Post. Facebook. Some of them get profitable right away and that’s great, but they’re the clear minority. 

That’s just how it goes. Plenty of people act as if it’s sufficient to say that a company is getting lots of traction but no/little revenue to say that it’s worthless. But all or most of the successful internet companies did that! 

Don’t get me wrong: you can have tons of usage and eyeballs and clicks and not be able to build a successful business. But saying that a company is not successful just because it “only” has eyeballs and clicks makes no sense. 

Let me tell you a story: I used to work with a consumer web startup that had had reasonable success—millions of users—but wasn’t really growing. I helped them sell advertising. We had innovative ad products based on our specific product and usage patterns, and advertisers liked it fine. But we couldn’t make lots of money. Why? Not because our business model sucked, advertisers liked what we sold. But because we didn’t have enough users. Because our user base was relatively small, we could only sell small amounts of advertising. Our problem wasn’t that we didn’t have a good business model, our problem was that we didn’t have enough eyeballs. 

chart of the day, sai, microsoft online operating income, jan 19 2012Microsoft doesn’t have a business model problem, it has an eyeballs problem

It’s true across the industry: Microsoft is losing zillions of dollars in search, and Google is minting cash. Why? Because almost everyone searches using Google, and almost no one searches using Microsoft. Microsoft has the best business model in the history of the internet—search advertising—and it can’t make money from it. It doesn’t have a business model problem, it has an eyeballs problem. Same thing with Digg, MySpace and so on. These companies didn’t fail because they couldn’t find a business model, they failed because people stopped going to their website. 

The internet is a medium, and media is about eyeballs. When you’re a TV network, your problem isn’t finding a way to make money, your problem is getting people to watch your shows, because that’s how you make money. Newspapers and record companies don’t have a business model problem, they have an eyeballs problem—people aren’t buying what they’re selling anymore. 

If you’re a startup and you have to choose between usage and revenue, you should almost always choose usage. 

Take a company like Foursquare: they want to be an interactive city guide. They want to be the app everyone who has a smartphone opens when they’re trying to decide where to do and what to go in the city. If they accomplish that, can they make money? The conservative answer is probably, because a platform like that would be valuable to tons of local merchants and venues. But one thing is certain: if people stop using Foursquare, it’s never going to make money. In other words, Foursquare’s number one business problem is eyeballs, not revenue.

Think of it as a two-by-two matrix: tons of eyeballs and a great business model is going to make you tons of money (Google); tons of eyeballs and a poor business model is still going to make you some money (let’s say: Demand Media), but no eyeballs and you’re toast, whether or not you have a great business model (Bing). So eyeballs matters more than business model.

Again, the point isn’t that things can’t be overvalued, or that it’s not possible for a no-revenue/no-profits startup to be worthless. The point is that it’s perfectly normal, and rational, from a business perspective, for an internet startup to focus on growth and usage at the expense of profits. This is particularly true of consumer internet startups, because it’s a media business, but it leads to increased perception of a bubble because consumer internet startups are also the ones that get covered the most. 

Google bought pre-revenue YouTube for $1.65 billion, and everyone thought that was crazy and sign of a bubble, and now YouTube is worth many times that.

There are other perfectly good reasons for web startups to focus on growth at the expense of profits:

  • Startups have very limited resources. That’s almost a tautology: a startup is supposed to be small. It means that there are only so many plates a startup CEO and executive team can keep spinning. And it means that when a startup is going up against powerful incumbents one of its few powerful weapons is focus. Instagram had less than 20 employees when it got acquired. All of its energy was needed to improve the product and scale the technical infrastructure and so on. Even if it had wanted to generate revenue, it couldn’t have made it work simply because its resources were so stretched. And it was the right call—not because it got acquired, but because otherwise Instagram would have gone sideways. In theory, the CEO can hire a “business person” to take care of the “business side” but in practice it almost never works out. Hiring business people means hiring less engineers and designers to scale and improve the product, which in a race against time can mean the difference between life and death. The point isn’t that startups shouldn’t generate revenue, plenty of them do and it’s great for them, but it is that there are very good, rational business reasons not to care about revenue early on other than “it’s a bubble” or “it increases our valuation.”
  • Plenty of technology markets have network effects and/or economies of scale. Network effects are what happen when a product gets more valuable the more people use it. Think of Facebook: Facebook would be useless if there were no one on it; but because everyone you know is on Facebook, you have to be on Facebook. Economies of scale means, roughly speaking, that you have to get big before you can get profitable. Markets with network effects and/or technologies of scale are markets where the number one player will be reaaally big and the number two and three will be small, or dead. It’s Glengarry Economics: number one gets a Cadillac, number two gets a set of steak knives, number three gets fired. This means that if you’re in one of those markets, you HAVE to get big fast, otherwise you’re TOAST. It’s not just a matter of a billion dollars being “cooler” than a million dollars. It’s a matter of a billion dollars or nothing. So for example Amazon is successful because it’s really huge and so it can get lower prices for everything and pass them on to the consumer. Because of this, it HAD to invest aggressively in growth, and forego profits for many many years before it could become profitable. A lot of people think it’s crazy to focus on growth at the expense of revenue, but if you’re in one of these markets (and a lot of technology markets are like that for a bunch of reasons too complicated to get into here) you’re crazy NOT to.
  • Plenty of technology trends experience exponential/superlinear growth, not linear growth. Humans are wired to extrapolate trend lines. The thing is that, largely because of those network and scale effects I talked about, many technology trends and startups have exponential growth. The problem is that it can cause us to fool ourselves: an exponential curve grows slowly at first, and then it starts shooting up. If you look only at the first part of the line, you think that growth is limited. But then it starts shooting up. This means that most of the value in internet businesses tends to be back-loaded: the net present value of an internet business’s future cashflows can often be a lot higher than previous numbers at “conventional” multiples suggest. So Google bought pre-revenue YouTube for $1.65 billion, and everyone thought that was crazy and sign of a bubble, and now YouTube is worth many times that. When PayPal went public after the dotcom bubble crash, the Wall Street Journal wrote that the US needed PayPal less than an epidemic of anthrax (!!); eBay bought PayPal for $1.6 billion and now it’s worth 10 times that, at least. Will it be the same for Instagram? Maybe, maybe not. But it’s not crazy to think so. 

The bottom line is, when you have tons and tons of usage, it’s almost always possible to find a way to make money. Eyeballs and clicks really do, at least more often than not, translate to money.

There are plenty of good reasons to give a no-revenue startup a high valuation, and plenty of good reasons why a startup shouldn’t pursue a revenue, beyond bubble mentality.

That’s all very fine in theory, but come on, you can’t tell me that there’s not something wrong with all these companies valued at hundreds of millions and billions of dollars.

Foursquare Users

Photo: news reports and company releases

Again: all valuations are a story you tell yourself about the future. Sometimes that story is wrong. But you can tell a credible story that some of these startups will make lots of money one day. You’re basically exercising probabilistic thinking: when you’re buying a seed round at a $15 million valuation, you’re not saying that the mockups these three Stanford grads have designed is worth $15 million now, you’re saying that there’s a 1% chance that it’s going to be worth $1.5 billion one day. And you might say that’s crazy and unmoored from reality, but the fact of the matter is, as I’ve pointed out, every valuation is like that, even when you’re buying stock in GE you’re making assumptions about their future earnings.So when you’re buying Foursquare at $500 million, you’re saying you think Foursquare is going to succeed at becoming the app everyone uses to explore the city, and that it’s going to succeed in making money from that, and so it’s going to generate zillions and earnings in the future, and you discount that to today. Can that be wrong? Absolutely. Is it crazy to think that it could be right? Absolutely not. Is it a sign of a bubble? No, no, no.

Seriously? colour raising $40 million? Instagram at $1 billion? Evernote at $1 billion? Dropbox at $5 billion? Viddly at however many hundreds of millions?
Again, this is why it’s important to look at specifics. 

Was colour raising at $40 million overvalued? Almost certainly yes. (Although, who knows, they could pivot into an amazing business.) But the thing is (again, we’re trying to figure out whether there’s a bubble), when colour raised that $40 million, the entire world exploded with derision. (Remember that hilarious pitch deck?) If this were like 1999, everyone would be talking about how smart that is, and about how great it is, and how to buy the stock when it goes public. And by the way it wasn’t that crazy, because colour was going after an opportunity—mobile photo sharing—which is clearly big. 

Instagram at $1 billion? Facebook gave up 1% of its market cap to get rid of an important strategic threat. (Photo sharing is the #1 use case of Facebook, and mobile is the future, and Facebook was nowhere in mobile photo sharing.) Maybe Instagram won’t be the next YouTube, but it’s certainly not crazy to think it will be. 

Evernote at $1 billion? The same Buzzfeed piece that says that if you know about tech you’re wrong about the bubble also wrote that “When Evernote gets valued at a billion dollars, it’s a bubble,” which clearly shows that you should know about tech before you opine on a bubble. Evernote has a magic business model. It’s a product whose value increases over time, which means that it is converting users from free to paid at excellent rates, and it is adding these users at a phenomenal rate, and it has very little competition, and it is addressing a very large market (everyone who owns a computing device and wants to remember things). Back of the envelope maths: Evernote now has 30 million users and adding more than 100,000 a day; if 5% pay $50/year for the premium version, that’s a $75 million revenue run rate. Given growth and usage, a $1 billion valuation is clearly not crazy. It’s so not crazy. Is it high? Possibly! But flatly stating “When Evernote gets valued at a billion dollars, it’s a bubble” means you’re misinformed.

Dropbox at $5 billion? Again, this is why it’s important to know what you’re talking about. As we explained at the time, Dropbox has magic economics. Is $5 billion high? Possibly. Is it a bubble valuation? Clearly clearly not.

Viddly at hundreds of millions? There’s clearly herd behaviour going on here: it’s an “Instagram-for-video” and people are buying it because they’re following the herd. But by all accounts it’s growing very fast. Would we invest in Viddly? No. (But then again we wouldn’t have invested in Instagram either, so ha!) But is it crazy to think that a mobile video sharing app can be big? No.

What’s the bottom line? The bottom line is this: There is no tech bubble. If you look at the fundamentals of businesses and financings that are going on, there are some things that are overvalued. But on the whole, things are not overvalued. 

Well, these valuations still look very expensive to me. I mean, at the end of the day, regular companies don’t get the same valuations as internet companies. 

global internet device sales forecast

Photo: BI Intelligence

Ok, so this is the part where I will completely discredit myself as a rational technology analyst, but here goes…yes, this time it’s different.The simple fact of the matter is that almost everything they told you during bubble 1.0 was not true then, but is becoming true now. 

As I wrote above, yes, eyeballs and clicks translate to dollars, at least most of the time. Maybe not as many dollars as anticipated, but still plenty of dollars.

The cloud has lowered the costs of running an online application by a factor of 100. There are billions of people online. Software is eating the world, which means it is going to eat every industry. We’re moving to a post-PC era which is shuffling the cards for everything and enabling the distribution of new apps. The scale of the internet opportunity is simply immense and is only getting larger (see chart).

Many people are going to use this quote to show that I’m crazy to say there’s no bubble, but even if you don’t agree with me about any of these, it still doesn’t change any of the facts I’ve laid out above. We’re simply not in a bubble.

Fine. Whatever. But if we’re not in a bubble, why does everyone say we are?
This is the most interesting part of that debate. People are so scarred by the previous bubble that even when the facts about the scale of the opportunities scream in their face they don’t acknowledge them. People who were around in 1999 remember those days less well than I do, and I’m 25. Whenever a company goes public people freak out even though that’s what’s supposed to happen. People are valuing Apple at a 14 P/E. And the freakout is massive. If there’s any sign of a tech bubble—a widely, strongly held belief that’s wrong—it’s an inverse, bizarro universe bubble, where people are massively underestimating the scale of the opportunity. 

But again, you don’t have to agree with me on that to face up to the fact that we are not anywhere near a tech bubble by any meaningful sense of the term.


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