Inflated Tech Valuations Bloat The Entire Economy
forbes.com
forbes.com
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?
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.
"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?
The author's point about how M&A traditionally happens is accurate. A team at Morgan Stanley or wherever looks at the company's numbers (cash flow, debt, growth rate, etc), and comes up with a valuation based on very concrete factual information. The target, if it's shopping, will have its financial advisers do the same thing. Then the CEO's will argue over those figures. It's a banker-driven process.
Tech M&A is often detached from that traditional process. A $19 billion valuation for WhatsApp didn't fall out of some Morgan Stanley analyst's spreadsheet. It's CEO-driven. It's a result of what Mark Zuckerberg thought it would take to buy the company. That's a very different process from how M&A valuation is traditionally done, and it's not wrong to point that out.
You're right though, in that I don't think all this means we'll end up with $500/lb chicken.
What if I told you that these "concrete factual information" numbers are just as made up as Daily Active Users, Monthly Active Users, number of downloads, etc. It doesn't matter what the number is, it's just whatever the market values. Right now the market values the numbers behind DAU, MAU, because well... Facebook and Google exist. They set the precedent of valuing MAU/DAU and have made money doing it, so the assumption is that any other company that also values these same metrics should follow suit.
Where I think we are in full agreement is the fact that DAU/MAU is not fungible. Meaning, the same 3hrs a day someone uses Facebook isn't the same 3hrs that someone uses twitter. But, lest we forget, the market is irrational.
EDIT: The fact that this "Mattermark" number exists explains the story even better than I can: http://mattermark.com/wordpress/wp-content/uploads/2014/02/f...
Really? I'd think it's a result of what the post-Morgan Stanley analysts who are now working at FB thought it would take to buy the company, not Zuck's whims.
And it's a price that is unique to FB. You can't take a private equity price and assume it has anything to do with the publicly traded value of a company at all.
When the UMaster does care, the deal is just a made up number that he pulls out of his, er, pocket.
Clearly he was implying pulling a number out of his ass which, as you know, is code for just making something up.
When someone accuses the CEO of a company as "just making things up" I see that as a lack of understanding of what information the CEO is using in their evaluation, and more importantly a lack of respect for the process at all.
That is how I reasoned to my, admittedly harsh, characterization of the author.
I learned to diversify more (event he "bluechip" tech companies had issues in the dot com bubble) and set reasonable performance targets for my portfolio. But mostly I learned that selling when you hit your target or your failsafes is essential to keeping sane.
#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.
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.
You don't know how much 12bln$ worth of Facebook stock is worth until you try to sell it.
Many keep repeating "there is no bubble", but it is hard for me to believe. The party has to end sometime.
Whereas, companies like Snapchat...
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.
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.
It's the hardware equivalent of ideas are cheap, but implementations are where real value lies.
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)
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.
(Spoiler alert - none of them think there is a tech bubble, at least not broadly)
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.
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?
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.