Are IPO valuations too bubbly?
The second we mention the words 'social' or 'cloud,' our objectivity in judging businesses dissipates.
That company, Instagram, gives smartphone users the ability to post photos to a half a dozen places, including Facebook and Twitter.
The Instagram acquisition has likely injected a lot of fertilizer into the angel investing bubble. I'm sure many startups are already raising money from angel investors dreaming of selling to the Facebooks and Googles (GOOG) of the world for billions.
The valuations of recent IPOs appear bubbly. Yelp (YELP), a terrific company (more on it in a bit), has a market value of $1.3 billion, and analysts expect revenue in 2012 to hit $180 million. Angie's List (ANGI) -- a website I recently used while remodeling the house -- has a valuation as silly as Yelp's, except that its website is a slight improvement over Craigslist.
I know the enormous appeal Facebook has to advertisers. Never before could businesses target customers with such precision. Facebook knows your address, your age, where you went to school, the music you like, your relationship status, where you travel, and more. And we volunteered all this information. I get it, it is incredible.
I've yet to meet a person who doesn’t think Facebook will do well on its IPO. But what if Facebook struggles to monetize its enormous user base? There are only so many ads it can put up on a page before they start impacting the user experience. The counterargument here is that since these ads are so finely targeted, they are more expensive and thus Facebook will not need as many.
What if people will simply get tired of the social thing? Social networking may turn out to be a fad, or at least the amount of time we spend it on it may decline a lot. I know large employers are blocking access to Facebook left and right; it is a huge productivity drain.
Zynga (ZNGA) is another stock that looks bubbly (though less bubbly than a few weeks ago; the stock is down 40% or so). Social games could be another passing fad. We recently purchased a company that may benefit tremendously from social games, but just as an added bonus. For Zynga, social games are everything.
I don't know if I am right on these stocks or not. Maybe their businesses will go at a much faster rate than I expect. But I can definitely sense that the second we mention the words "social" or "cloud," our objectivity in judging businesses dissipates.
This also applies to boring, real companies feeling the pressure to be in the space and paying insane valuations for dot-social and dot-cloud businesses. (CenturyLink (CTL) buying Savvis at 10 times earnings before interest, taxes, depreciation and amortization comes to mind). My concern is that these real companies will overpay for their dot-stuff.
The last time I was in San Francisco, a portable GPS was a very expensive novelty. That was early 2006. My best friend and I were on a road trip, driving from Denver to San Francisco and back. We had a GPS attachment connected through a USB port to a laptop and used Microsoft mapping software. All phones were dumb (even BlackBerry, the smartest phone at the time, was dumber than a brick compared to today's iPhone).
This time around, armed with iPhone, I was surprised how good the Yelp app was. Though the company is trying to expand, Yelp is mainly a social app where users review and rate restaurants. It is crowdsourcing at its best.
All I had to do was type "sushi," select the distance I was willing to travel, and Yelp showed me all sushi restaurants around me and their ratings. In the absence of any other data points, you start heavily relying on Yelp's ratings, especially since many restaurants have several hundred reviews.
The feature in the app that I found astonishingly innovative was the "monocle." You click on the monocle button, point your iPhone in any direction, as if you were taking a picture, and it shows you the restaurants and their ratings in that direction.
Apps like Yelp's will have a significant impact on restaurants. They facilitate the word-of-mouth restaurant recommendations between friends and extend them to strangers. They'll also likely expedite the failure rate of restaurants. Restaurants with high reviews will get more customers, and the ones with poor reviews will die a quicker death.
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates, a value investing firm in Denver. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here or read his articles here.
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