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Internet Bubble 2.0?

One thing the mortgage meltdown of 2008 accomplished was entrenching the word “bubble” into the business vocabulary of investors and business builders. We all know by now that the real estate bubble of 2000 to 2008 was created by the Fed’s “easy money” policy, which the Fed introduced to help investors recover from the bursting of the Internet bubble in 2000.

Have we now come full circle? Are we now in the middle of Internet Bubble 2.0? Some would say yes, after the report last week that Goldman Sachs put a $50 billon dollar valuation on Facebook when investing $150 million in the company.

So what exactly does a “bubble” mean when it comes to investing and valuations? Well, first bubbles float ever higher. Second, they are easy to burst, which sends then plummeting to earth. But the real issue behind an asset bubble is that valuations become speculative, and are driven by momentum and market sentiment, rather expected cash flows.

Facebook is a private company that reports neither revenue nor profit or cash flow. But if the average web business is selling at 1-2 times revenue… no one is suggesting that Facebook’s revenue is $25 to $50 billion. Not even close.  But analysts are careful to report that Goldman had other reasons for investing in Facebook that were tied to solidifying the relationship in anticipation of underwriting their eventual IPO. The common sentiment is that Goldman expects to generate a return on its investment through fees, rather than by selling at a higher valuation. 

We do, however, see other extravagant valuations in the Internet space. Groupon, the local discount coupon company, is also being valued at outrageous revenue multiples. So is Internet Bubble 2.0 really here?

Our feeling is no. Although there is a speculative buzz at the high end of the market, the mainstream market is marching on as usual. The first time around, in 1999, third tier online pet food sites without traffic or revenue, were attracting outrageous multiples.  There is no parallel to that in today’s market. While a nice speculative buzz surrounds a few sexy companies at the top of the Internet food chain, everywhere else it is business as usual.

If you are dreaming of a big pay day in relation to your online business, it is going to have to be earned the old fashion way through strong business performance. Don’t count on cashing in with a highly speculative multiple.

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