Enter you email address and zip code to set up customized email alerts.
Ben Horowitz is the co-founder and General Partner of the venture capital firm Andreessen Horowitz
I’m going back to Cali, Cali, Cali I’m going back to Cali…hmm, I don’t think so —LL Cool J, Going Back to Cali
Lately, everybody seems to be talking about a new technology bubble. Many very smart CEOs, VCs, reporters, and analysts can’t seem to stop worrying about the second coming of the dot com bust. Are the prognosticators correct? Will we head mercilessly into another crash? I don’t think so.
A Comparison Between Today’s “Bubble” and the Last Tech Bubble
Since so many distinguished people report a broad variety of qualitative bubble signs, let’s attempt to pattern match the quantitative data. As we do so, keep in mind that the relevant bubble statistic is not valuation. It’s the valuation:value ratio. High valuations are fine if the underlying value is there. Let’s look at public market comparables and venture capital flows to see if we can find a match.
1. Public market comparables
In the great bubble of 1998-2000, the boom in public valuations mirrored the boom in private valuations. Similarly, in recent high profile private financing rounds for private technology companies with valuations over $1B, the valuation multiples were at or below corresponding multiples for publicly traded companies such as Google. This has generally been the case for the bulk of deals that we’ve seen at Andreessen Horowitz. If publicly traded technology companies are not at bubble-like prices, then private technology valuations aren’t either because they are roughly equivalent.
To find out whether or not today’s public technology companies have hit bubble valuations, let’s compare some companies that survived the great bubble with their bubble era valuations:
Image: Ben's Blog
The Enterprise Value-to-Revenue multiple (EV/Rev) and Price-to-Earnings multiple (PE) are commonly used metrics to tell the valuation:value story. Companies that produce little value today might still receive high valuations due to high growth expectations. The PEG Ratio normalizes the valuation:value ratio for growth expectations by tracking the valuation:value ratio per unit of expected earnings growth.
Bubble era valuation multiples were more than 10 times higher than current comparable multiples. As you can see, not all of these multiples are comparable as some of the bubble era multiples were NM—not meaningful—due to negative earnings. This means that the valuations ascribed to these companies were not quantitatively based on the earnings they were generating or projected to generate.
The valuation:value ratio of today’s private and public technology companies look nothing like the bubble ratios.
2. Venture capital flows
A basic driver for a private technology market bubble is the over-supply of venture capital into the sector. If too much venture capital hits the streets, valuations will bubble up. The inflation-adjusted data from the last bubble tells the story:
In the 3-year period from 1998-2000, venture capital firms raised more than $200 billion, which represented about 0.55% of the national GDP. To put that in perspective, that’s more money than the entire venture industry raised collectively over the prior 18 years.
Flush with lots of capital, venture capital firms naturally invested at historically high rates—from 1998-2000 alone, venture capital investments also topped $200 billion. Again, more dollars were invested in this single 3-year period than in total over the prior 18 years.
Now let’s take a look at the current version of the same inflation-adjusted data:
Total venture capital raised from 2008-2010 was just shy of $55 billion, about 0.12% of the national GDP, with the trajectory of capital raising declining in each year. In fact, 2010 venture capital fundraising is at the same level as it was in 1995 and 1996.
Approximately $90 billion has been invested by the venture capital industry from 2008-2010—less than half of the 1998-2000 level. More significantly, total capital invested should continue to remain constrained in light of the significant reduction in new venture capital dollars raised over the last 3 years. Keep in mind that because the life of a venture capital fund is generally 10 years, it takes a while to see the impact of lesser fundraising on total dollars invested.
The inflows don’t actually look that bubblicious.
The Long Awaited Arrival of the Internet Boom
Looking at the numbers in the previous section, you may be wondering: “how in the world did people get so totally out of control in the last bubble?” The short answer is that the expectations of the great Internet boom vastly outstripped the actual activity. Specifically, the market wasn’t nearly as big as anticipated and the products were not nearly as good as imagined—at the time.
When Netscape peaked in the late 90s, we had 90% market share and 50 million users. The total Consumer Internet market was 55 million people. That’s about 36X smaller than today’s 2B. Worse yet, over ½ of those 55 million were dialup users. In addition, to horrible bandwidth and latency, the technology products were very crude in other ways. Programming languages were radically less functional, hardware was literally a hundred times more expensive, and there was no virtualization or cloud computing or AJAX. Constrained by such an early and weak technology platform, companies built poor applications. As a result, the expectations of what the Internet would be radically outstripped the reality of what it was. And hence the great crash of 2000 and 2001.
Since then and over the last 10 years, everything has gotten better. Much better. Servers moved from proprietary systems made by Sun, IBM, and HP to commodity hardware at a fraction of the price while radically improving in performance. The open source movement dramatically reduced the cost and improved the quality of systems software. Average consumer bandwidth increased 100 fold due to cable modems, DSL, and high-speed wireless networks. Cloud computing, which was not available then, now enables companies to build massively scalable products with very little initial capital outlay. The combination of the Internet and open source transformed the functionality in modern programming tools, increasing developer productivity 10 fold. The resulting applications have been so easy to use that even older generations of consumers now rapidly adopt new technology like Facebook. And there are 2 billion people on the Internet. All of these factors have led to an exciting new set of leading companies, including a special few which grew to over a billion dollars in annual revenue in less than 5 years. Welcome to the great Internet Boom of 2011.
At this point, you may still be worried about the startling rise in valuations of privately held technology companies. As I mentioned before, privately held technology companies trade at reasonable valuations vs. publicly traded comparable companies. These public companies trade at reasonable valuations vs. historical precedents.
In addition, these companies are significantly more mature—in terms of revenue and profit generation—than their counterparts in the last bubble. For example, the 1998 IPO class had average revenue of $120 million (and net losses of $65 million to boot). If you just look at the tech IPOs that have been completed year to date from 2010, the average revenue of this group is north of $300 million.
What about companies with reportedly very little revenue and very high valuations such as Twitter? A good investing rule of thumb is that any company that simultaneously saves Charlie Sheen’s career and starts a revolution in Egypt may be on to something. While Twitter doesn’t make that much money yet, historically media companies that capture hundreds of millions of highly engaged users tend to be make money. Continue reading » 1 2
View as one page
To embed this post, copy the code below and paste into your website or blog.
"You can't bet against her."
Time Lapse Satellite Photos Show How Humans Are Destroying The World 214,564 Views
CAUGHT ON TAPE: Former SEIU Official Reveals Secret Plan To Destroy JP Morgan, Crash The Stock Market, And Redistribute Wealth In America 183,426 Views
The 10 Best Features In Firefox 4 181,807 Views
GARY SHILLING: And Now House Prices Will Drop Another 20% 175,841 Views
Here Are The 11 Countries At Risk Of Becoming The Next Libya 159,818 Views
CAUGHT ON TAPE: Former SEIU Official Reveals Secret Plan To Destroy JP Morgan, Crash The Stock Market, And Redistribute Wealth In America 211 Comments
Why The War In Libya Is America's Most Principled War In Decades 56 Comments
ALTUCHER: The Media Owes Everyone An Apology For Overhyping Japan Nuclear Crisis 55 Comments
Read Full Article »