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The Long Bubble

Posted February 19th, 2012 by Andrew Goodman

High level principles here, not a raft of charts, facts, and stats. Some of it is speculative.

With that out of the way, let’s have a deeper look at the warped reality field you’re likely to have to endure over the next couple of years.

As we’ve seen blatantly from recent asset bubbles in stocks, dot com funding, and housing: money and assets warp reality. There is a certain solidity in what is “making money,” even if it’s money borrowed from other people, or the future. That whole tranches of blended, not really blended, subprime loans with a diversified, not really diversified, risk pool, were rated AAA sort of illustrates how seemingly “solid” investments and industries can be just as illusory as any other.

In the next couple of years, everything’s going to be fine for Facebook.

Facebook isn’t going to face any cash flow problems because it’s going to raise billions in an IPO at a reported valuation of $100 billion, on top of all the money it has already raised. It’ll be able to buy just about anything it wants. It’ll be able to delay the pace of monetization in order to improve user satisfaction. It’ll be able to recruit great talent.

Compounding that warping of reality will be convenient devices like their symbiotic relationship with Zynga. Zynga, for their part, enjoy a stunning $9 billion market valuation. They also make up more than three-quarters of all the “fees and subscriptions” revenue shares Facebook enjoys. Facebook has every reason to be nice to Zynga. Zynga has little reason (for now) to be anything but grateful to Facebook.

There is no question that both are big, happening companies. Facebook is enormous enough that its advertising program and other visibility options for advertisers can and will become impressive. But the reality is, they aren’t doing all that well (from the standpoint of advertising programs) for a company that has raised the amount of money it has. And with their own IPO money sloshing around, along with a lot of other bubble money sloshing around and heading Facebook’s way, the financials the public sees are likely to be a pretty warped reality field. Facebook can delay full monetization for years, just as Google has done with YouTube and Google+.

Being so well funded, companies like these may look better than they are. Do they ask they hard questions about massive de facto subsidies of partners and product? Monetize intelligently and truly serve advertisers? Will their expansion plans and mass hires lead to a culture of excess and entitlement? Those are all bad precedents to set and eventually these matters need to be addressed when the easy dollars stop, and the hard dollars need to be made.

If you’re enjoying a first mover advantage or an investor-driven subsidy, things look pretty good until you start coming up against an even bigger subsidizer (Google, for example), or when the market for what you’re doing turns down in an economic sense.

Due to the mutually-supporting nature of the assets driving this long bubble, the financial picture painted can be a rosy one for a long time to come, much as the housing bubble went on partying right up until it crashed.

Speaking of that, a look at a long list of recent digital media IPO’s turns up a raft of companies with no earnings or extremely high P/E ratios: Pandora, Zillow, Liveperson, LinkedIn, Angie’s List, and the list goes on. The majority of these companies have continued to float along in suspended animation at high valuations. Those with solid financials, like TripAdvisor and Demand Media, have garnered relatively little respect. Such is the bizarro world of “story” companies that aren’t judged on financials but on future prospects (as long as they don’t run through all their cash).

When the cash is flowing a little less freely, and the myriad “coopetitors” take the gloves off on partnership terms, start laying people off, spending less on product, and cutting back marketing dollars, someone’s going to get hurt — not least investors who buy into “easy money” revenue numbers and fail to see the challenges on the horizon. There are finite limits to this universe, and the phenomenon of users getting bored and ignoring the ads — always one that created a sense of productive paranoia at Google — hasn’t been much ┬ádiscussed by analysts of many of these companies. But then again, many of these companies are new to the monetization thing.

2 Responses to “The Long Bubble”

  1. aaron wall says:

    Are Demand Media’s financials “solid”? :D

    Outside of that, yet again another great post.

    The Wilshire 5000 closing in on on its all time high. What’s the “easiest” way to short this pig? ;)

  2. Andrew G says:

    On Demand Media, “solid” was certainly an overstatement of the financial picture. (At the very least, it’s an underrated company that has already taken some lumps as far as real world pressures and the resulting devaluation, so its challenges may be more priced into the valuation than in some of the other cases.)

    Disclosure: I hold neither short nor long positions in any of the companies mentioned in this post.


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