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Bubble, toil and trouble

Companies that have never generated any profit are still raising millions. Are we approaching tech bubble 2.0, asks Ian Vella.

Friday, March 10, 2000 was a black day for technology companies. The Nasdaq stock exchange opened as usual at 9am but the outlook wasn’t looking good. In fact, stockbrokers were already expecting a disastrous day as in the preceding week, hundreds of tech companies had started going bust. Many 20-year-olds, who were already millionaires after setting up their companies in Silicon Valley, had already moved out of their multi-million properties and were back to where they had started: a room at their parents’ house.

As the hour hand approached noon, the Nasdaq tech listings were already down 55 per cent and by closure time the figure went further down to 78 per cent. It was a complete washout. Silicon Valley, which just weeks before was buzzing with enthusiasm as young entrepreneurs from around the world were setting up shop, went suddenly and eerily silent.

Banks immediately sent their repossession agents to take over entire buildings in the hope of recovering some of their debts. Over that weekend Silicon Valley was transformed from the tech place to be into a ghost town.

Yet the meltdown wasn’t as sudden as it appeared to be. Many experts had been warning about this for years. The tech bubble, which had started around 1992 with many investors throwing money at fancy online companies – even those based on the most stupid of ideas – just wasn’t sustainable. At some point, it had to burst. Which it did.

The victims were many but most had written their own destiny. The online company www.boo.com, which had been founded just one year before the dot-com bubble, had spent more than €100m in advertising without ever registering a profit. The first social network, www.theglobe.com, was launched in 1994 and offered many of the services that Facebook provides today. In 1998, the company’s shares were worth €7. One year later, the shares were trading at €78. However, when the bubble burst, its shares went down to three cents in just one week.

The website www.broadcast.com proposed a very good idea at the time: transmitting radio and television shows online. Investors were literally pouring money into this company and it managed to raise more than €4bn. However, the company founders’ idea hinged on one very important element: the availability of broadband internet by 2000. Broadband connectivity only started entering homes around 2008. The company burnt all the money it had raised in a few months.

Fast forward to the present day and most of the ideas floated in 2000 have become reality. Facebook is the new Globe, Ebay is the new Boo and Netflix does what Broadcast promised it would do. That essentially means one thing: that the companies that went bust in that fateful March of 2000 didn’t fail because their ideas weren’t innovative enough. Rather, the main culprits were greed and lack of planning.

Do we know better today? Not necessarily. History is destined to repeat itself and the lessons learnt just 15 years ago are not enough to stop greed.

Today it is estimated that eight to nine out of every 10 new start-up companies fail mostly because they grow too fast. Some companies are having great success with one particular product or app launch and are expecting each and every product they launch to achieve the same profit levels. The stock of King Digital, producers of the hit game Candy Crush Saga, is already dropping after the company failed to replicate the success it achieved with newly launched games and apps. The Anglo-Swedish company recently issued a downbeat forecast which sent its shares down 21 per cent.

The same thing is happening to Zynga and Rovio, creators of Farmville and Angry Birds respectively. It seems that these companies are the tech equivalents of pop one-hit wonders: instead of launching a series of hits over a number of years, which would have helped them build a sustained and sustainable business model, these companies are failing to live up to the expectations generated by their first hit.

King Digital’s initial public offering price was set at €17.63 per share last April and all shares were snatched immediately. Today, the same shares are trading at roughly half that value: this means that investors lost half their money in less than six months because they expected King Digital to be able to replicate sales for all their games.

Other companies with great ideas but absolutely no revenue are raising extraordinary amounts of money in venture capital. For instance, since launching in 2011, www.fab.com, an e-commerce company, managed to raise over €260m. And yet, the same company has never registered any profit. Earlier this year, it was forced to fire 400 employees after it had to downsize because it couldn’t cope with its salary bill.

The list goes on. Snapchat, a photo messaging app developed by three friends during their summer break at university, is being valued at over €2bn and it has yet to make a profit.

Huge companies like Yahoo are once again starting to acquire companies for unrealistically high valuations just like it in 2000. Yahoo’s largest fiasco, back in 1999, was when it bought Geocities and never even recouped its initial investment. Nevertheless, last year Yahoo bought Tumblr for more than €800m, even though Tumblr is not expected to break even in the coming years.

Timothy Draper is an American venture capitalist who was one of the first investors in Hotmail and Skype: when both were sold to Microsoft, he made millions. He is definitely one man you should listen to. In a recent interview with The New Yorker, he said that, “Tech venture capital may have reached the top of its cycle once again”.

Draper’s theory is that after a recession, lots of people including intelligent business-minded youngsters lose their jobs. People start noticing that it is easier to start a business instead of finding a job and millionaires with lots of extra cash suddenly find it more lucrative to invest in such start-ups rather than risking their money on the stock exchange or leaving dead money in a bank with zero interest. After some successful business stories are rolled out in the media, people start thinking that they too can be successful while investors start believing that anything they touch will turn to gold. This leads to sloppiness and eventually to a market crash.

This is what happened prior to the 2000 crash and according to Draper we are now at a point where negligence is blurring business decisions once again, only to inevitably lead us to the unavoidable market crash. Let’s just hope that this time the cycle is broken before the inevitable strikes again.

Ian Vella is a search engine optimisation specialist.

www.ianvella.com.

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