For venture capitalists, entrepreneurs, policy-makers, and even ordinary investors, a big question is whether were in the midst of an information technology bubble resembling the one in the 1990s. Today, some experts are making plausible cases for a bubble, while others say that such assertions are highly premature.
Regardless of which side of the argument you find yourself on, its clear that new companies and business models are emerging almost out of nowhere. The Trends editors refer to the on-going transformation of the economy by digital technology as the "fifth techno-economic revolution."
While this revolution began in the 1970s, were now just a little past its mid-point. As weve explained in prior issues, the exponential improvements in the price-performance of computation, storage, and bandwidth will create entirely new industries and applications, some of which will be as transformative as electricity, railroads, and mass production were in the 19th century.
One of these fundamental technologies is called "assistive artificial intelligence." Its applications will include:
- Real-time language translation
- "Predictive analytics" that transform "big data" into actionable business decisions
- Expert systems that will make us all more competent
Other emerging information megatechnologies will be:
- Ubiquitous mobile computing, which is already letting us access anything, anytime, anywhere.
- Quantum computing, which will enable us to solve todays insoluble analytical problems.
- Service robotics, which will include pilot-less airplanes and driver-less cars.
These direct applications of information technology will enable new industries that will become the hallmarks of the fifth techno-economic revolution.
These industries include:
- Biological engineering
- Synthetic biology
- Personalized medicine
- Nanotech materials
- Micro-electromechanical systems
- Distributed energy generation
As explained in prior issues, the opportunities for semiconductor firms, software firms, and network providers, as well as those who can leverage infotech to create new "networked business models," are huge. In essence, this revolution will transform nearly every aspect of our lives over the next 20 years.
However, with the notable exception of Apples return to the top, the big winners so far have all been companies that have used "network effects" to achieve a competitive advantage in consumer markets. Examples include LinkedIn, Zynga, and Zillow. Meanwhile, some older firms, such as Amazon, Priceline, and Google, have continued to exploit network effects to create huge market valuations and build on their pre-existing success.
As these tech-based companies emerge and thrive, some argue that they are creating the first foundational component necessary to produce a bubble, that is "investment targets that encourage irrational exuberance."
Theres no question about the existence of the second necessary component ? "investors hungry for big returns." Many investors have been waiting in the wings, frustrated with the scarcity of IPOs over the past decade and a lack of other good investment opportunities. As Eric Hippeau, the former CEO of the Huffington Post and a partner at Lerer Ventures, puts it, "Weve been in a desert for IPOs, so its normal [that] people would flock to Internet companies that are going out now."1
According to Paul Saffo, a longtime Silicon Valley observer, "Investors are desperate for something ? anything ? with a prospect of returns, and there is a lot of hot money looking for a home."2
The concern is that this pent-up desire to invest, coupled with flashy emerging technologies that are bursting with promise, will entice investors to jump in without truly weighing the risk. In fact, some say this is happening already, pointing to what they see as recent overzealous enthusiasm for Internet company IPOs.
So far in 2011, of 90 IPOs, over a third have been for technology companies. According to Fortune3 magazine, 50 tech-firm IPOs are expected this year, which will make this the busiest year for such offerings since the peak of the dot-com bubble in 2000.
In the second quarter of 2011, IPOs raised $12 billion, more than twice as much as the same quarter a year earlier.
Consider the following:
- Zillow, the home-price Web site, went public in July in an IPO at $20 a share. By the next day, the price had doubled to $44 a share. What makes this notable is that the company has yet to show a profit. Evidently, investors are attracted to its potential simply because it has a strong presence on the Web. That is an echo from 1999, when companies that werent making money realized big IPO success simply because their names ended in "dot-com."
- LinkedIn, a networking site for business professionals, is another recent dot-com that had its IPO double the price target at its launch earlier this year. Its been trading at a phenomenal 750 times its forecast 2012 earnings, compared to an average for the rest of the market of just 12 times estimated earnings.
- Pandora, an Internet radio station, also doubled its price at launch. Investors bid its value up to $2 billion, ignoring the fact that the company is pumping out red ink.
- This past May, Microsoft purchased Skype for $8.5 billion. That amounts to ten times its 2010 sales and 400 times its operating income.
- Even fledgling firms are soaring in value in the private market. Case in point: Color, a photo-sharing social network with an untested business model, is estimated to be worth $100 million.
Whenever investors bid up the price of these companies because they expect them to keep going up, rather than because of such basics as a strong balance sheet or a solid business model, then there seems to be clear evidence of a new tech bubble.
This view is bolstered by other pieces of anecdotal evidence that a tech bubble is forming around Silicon Valley. For example:
- First, the real estate boom seems to have returned to Silicon Valley, with the biggest short-term gains since the boom days of the late 1990s.
- Second, bidding wars have begun for the next generation of extraordinary engineers.
- Third, words and phrases reminiscent of the dot-com boom can now be heard in the Valley. These include tidbits like: "Theres a wave ? ride its crest." Even if there is no bubble, there is talk as if there is one. Or perhaps, theres just hope that such talk will help start one.
In spite of this evidence, there are many who dont believe a bubble is forming, and they offer strong arguments for their conclusion.
The key point in this argument is that the Web environment is not what it was when the bubble burst in 2000.4 There have been three substantial changes:
- First, the use of the Internet has grown substantially since 2000, with eight times as many people now using the Web. That translates into 2 billion people, with a large portion in huge, newly wired markets, such as China.
- Second, the Internet has developed the capability to deliver content and services, increasing its value beyond just another way to sell products, which enabled the emergence of Amazon and eBay. Driving this change has been the widespread accessibility of ultra-fast broadband connections, a feature that was rare in the late 1990s.
- A third change is in the area of revenue. Last time around, most Web start-ups had lofty ambitions and goals, but insignificant revenues. Today, that has changed. More of the businesses that are attracting the attention of investors this time can point to working models and real track records, not just slick new ideas and rosy promises of big returns. Additionally, they generally have large customer bases. Groupon and Zynga are two examples, both showing phenomenal sales with decent profits.
The takeaway is that it is now possible to make lots of money on the Web. It is no longer a pipe dream, unworthy of investors dollars.
Industry leaders agree with this analysis.
Eric Hippeau states, "I would not characterize it as a bubble like 2000 or 2001, simply because if you look at the companies that have gone public, they have substantial businesses which are market leaders with revenue growth in the double digits."
Venture capitalist Marc Andreessen, a founder of Netscape, suggested to the Associated Press in March, "I dont see a bubble. I think people are confusing success with a bubble."
In light of this trend, consider the following five forecasts:
First, its highly likely that several Internet companies will reach astronomic valuations after going public that have no basis in reality ? but, at the same time, other Internet companies will soar, and will be worth every penny of their high prices.
Its worth remembering that eBay, Amazon, and Google have evolved into profitable businesses, while high-flying dot-coms like Pets.com and eToys crashed and burned. Similarly, as todays Internet companies go public, wise investors will focus on each companys business model individually, rather than assuming that all tech companies are equally attractive. For example, Facebook dominates the social networking space. It has been generating big revenues from advertising, is rumored to have reached $1 billion in profits, and may be the next Google. At the other extreme, when Groupon finally gets around to launching its IPO, investors will need to consider whether it can defend its turf in the Internet coupon space against competitors like LivingSocial and Google. But even Groupon is a better investment than most of the late 90s dot-coms, because it is a real business with real revenues and real profits.
Second, the experience of the first dot-com crash will help to prevent todays enthusiasm for Internet companies from turning into a full-blown mania.
The people who remember the last tech bubble will be cautious enough not to get carried away; the fact that were even asking whether a bubble is possible at this stage shows that this is nothing like the late 90s. Until greed overcomes fear, which is the psychological scenario that drives irrational exuberance, any bubble will be kept in check.
Third, the lack of IPOs and their exclusivity, to date, limits the potential harm from any bubble that might burst in the near-term.
Arguably, the lack of good investment options has led investors to overpay for the few deals that have hit the market, so far. Luckily, unlike what we saw in the late 90s, these over-valued IPOs do not represent a huge portion of total stock market capitalization. Currently, investments in many tech companies IPOs are open only to the clients of firms like Goldman Sachs and top venture capital firms. Although this means most investors cant benefit from the meteoric rise that many IPOs experienced in the late 90s, it also means that if a bubble should grow, the losses will be much more contained, and they are unlikely to hurt the broader economy in any major way.
Fourth, over the next decade, creative destruction will replace outmoded enterprises and make way for lots of new companies with enormous potential.
Once weve put the Great Recession behind us, expect to see two decades of technology-driven growth as new companies enter the market and old ones vanish. Over that period, expect to see one or two run-of-the-mill recessions. To answer the question of whether or not we are seeing a new "tech bubble" heading toward a burst, we can paraphrase Winston Churchills quote regarding the end of the Battle of Britain: "This is not the end. Its not even the beginning of the end. Its merely the end of the beginning."
Fifth, what many people are mistaking for a new bubble is simply the transition from the second to the third stage of the "fifth techno-economic revolution."
In other words, once we get past "the end of the beginning," the good times will start. The next round of companies will largely be those that go beyond using "network effects." Many of those winners will be new or established companies that make the chips, software, network infrastructure, and integrated systems that will enable other key technologies, like personalized medicine, distributed energy production, and service robotics to flourish. IBM is an example. Its not only developing molecular-scale processors and assistive AI technologies (like the supercomputer called Watson); its also creating new chips that help computers mimic human learning. All of this will create a world in which everything is linked to everything else in multi-tiered networks. Rather than peaking quickly in an event reminiscent of Y2K, these industries will provide ever-expanding waves of demand through at least 2030.
References List : 1. Reuters, July 21, 2011, “Welcome to Tech Bubble 2.0 -- When’s the Bust?” by Brent Lang. ⓒ Copyright 2011 by Reuters, LP. All rights reserved. http://www.reuters.com 2. Ibid. 3. Fortune, July 25, 2011, “Don’t Call It the Next Tech Bubble ? Yet,” by David A. Kaplan. ⓒ Copyright 2011 by Townhall.com. All rights reserved. http://tech.fortune.cnn.com 4. The Economist, May 14, 2011, “The New Tech Bubble.” ⓒ Copyright 2011 by The Economist Newspaper Limited. All rights reserved. http://www.economist.com
