Caught In The Webb

Everything You Ever Wanted to Know About Why We’re Definitely in a Bubble

A thoughtful dialectic with our esteemed columnist on why we’re in a social/media bubble.
rickwebb 682x1024 399x600 Everything You Ever Wanted to Know About Why We’re Definitely in a Bubble

Mr. Webb

Bubbles bubbles bubbles! The talk continues. Last week the anti-bubble camp was in the ascendency. First we had a massive bubble debate on Branch.com (disclosure: I am an investor in Branch), featuring some of the best minds on the internet: Anil Dash, Dave McClure, Paul Kedrosky, Chris Sacca, Michael Arrington, MG Seigler and more. The rough consensus? No bubble.

In wrapping up the Branch debate, Seigler pointed to First Round Capital’s Josh Kopelman, and his hilarious bubble post – from 2007, no less – mocking those who continuously cry bubble, and failing to grasp the transformational power of the internet. A fair point.

Next we had Business Insider Henry Blodget’s presentation State of Startups 2012 presentation, subtitled “No, it’s not a bubble.” Many charts, graphs and points followed laying out why the bubble doesn’t exist.

I must confess, however, I’m in the pro-bubble camp, and while reading the Branch debate, I found myself jumping up and down with counter arguments on why we actually are in a bubble. And, since I’ve taken a two week vacation from this column, I figured I’d come back with a vengeance, and cogently lay out all the arguments and counter arguments.

I’ll start off by promising the anti-bubble posse that I will barely mention Instagram at all, and when I do, it will be only in a tangental manner. I promise.

 

What is a bubble?

The definition of a bubble is an important part of this debate. Chris Dixon expresses justified annoyance at this when he says “A bubble is a financial event. I don’t understand people who try to discuss it without bringing financial evidence into the picture.” This is a valid point.

Economists generally agree that three things must be present for a bubble to exist: (1) high trading volumes, (2) prices that are different from their “intrinsic values,” and (3) that said difference between prices and intrinsic value must be considerable.

The Wall Street Journal puts it thusly: “Bubbles emerge at times when investors profoundly disagree about the significance of a big economic development, such as the birth of the Internet.”

Built into that definition are our key three items: disagreement would indicate considerable variance in price, and a big economic development implies high trading volumes. “The internet” or “the railroads” are big economic events. And because they are big events, there will be a lot of trading around them.

 

What a bubble is not

Just as important is what a bubble is not. A bubble doesn’t have to be in the stock market. Tulip Mania, the first bubble, had nothing to do with stocks. Subsequent examples abound. Many of the anti-bubble defenders base their arguments on metrics around the publicly-traded tech companies, talking about their P/E ratios for example. The P/E ratios of publicly-traded internet companies, such as LinkedIn, are within normal parameters right now. This, however, has nothing to do with “ALL” Internet companies, only the ones that are publicly-traded. No one realistically believes the bubble is in public companies, and the definition of a bubble does not require the bubble to be in publicly-traded companies.  Any arguments against a bubble that solely rely on P/E ratios of public companies aren’t really relevant and indeed help obscure the true picture.

Additionally, a bubble is not tied to the economy as a whole. Joseph Schumpeter had a notorious aversion to looking at large economic trends when trying to discern what was really going on. He said “It is, therefore, misleading to reason on aggregative equilibrium as if it displayed the factors which initiate change and as if disturbance in the economic system as a whole could arise only from those aggregates.” (Look to p 36 here).

Economist Carlota Perez, something of a hero of Union Square Venture’s Fred Wilson, takes the point further, stating that bubbles have nothing to do with the economy as a whole. “It is not even likely that the turbulent process by which new paradigms are assimilated should lead to regular up an down trends in the economy as a whole.” (Page 36, of her seminal work Technical Revolutions and Financial Capital).

These are both important points, as many of the arguments against a bubble point to metrics from the stock market as evidence for the lack of bubble. Fact is, economists don’t care whether or not a bubble is in the stock market or trends with or against the larger economy.

It should also be said that bubbles have nothing to do with many of the things we hear about – anecdotal evidence of “founder friendly” terms, bankers going into tech, a bajillion ripoff tech companies managing to get funding, lavish parties, kid founders, etc.

 

Why we’re in a bubble

So, then, it shouldn’t be that hard to see if we’re in a bubble, right? If our three criteria our met, we’re in one. Bob’s your uncle.

First, I’d posit that this is not a “dot com” bubble. I believe the bubble we’re in is a social/mobile bubble. I say this for a number of reasons: social/mobile companies have higher valuations than many of the other tech companies out there, and they garner considerably more press. It’s easy for us to think of the entire dot com sector, thanks to the previous dot com bubble, but in fact we have several sub-markets now. When Chris Dixon says “Instagram aside, there is SUBSTANTIAL revenue and even profits being generated by a much larger # of companies than ever before,” he is generally mixing all tech companies together. There are indeed several tech companies producing substantial revenue. But what percentage of social/mobile companies are?

Let’s look at those three pillars of the definition:

Trade is at high volumes
Social mobile companies are proliferating. Many are getting invested in. TONS of them. We all know this. We see new deals every day on Techcrunch, VentureBeat, Betabeat, etc. Perusing the Branch discussion, everyone agrees there’s some “froth” at the early stages for “certain” types of companies (i.e., social/mobile).

But all this is, of course, subjective. So let’s look at Blodget’s empirical data. Despite some blurring at the beginning, in his Anti-Bubble presentation, Blodget points out VC investment in tech is increasing, now, even in a down economy.

Prices are “considerably at variance to intrinsic values.”
So let’s turn our attention to pricing. There are two parts of this equation: (1) considerably at variance and (2) intrinsic values. Let’s go one by one.

(1) The very existence of a plethora of heated discussions on bubbles should be enough evidence that investors profoundly disagree. The tepid IPO market vs. the number of companies aiming to IPO, along with their substantial number of backers wishing for the same thing, should indicate two parties who substantially disagree on value, considerably.

(2) “Intrinsic value,” of course, is a bit more complicated. This has always been the sticking point for any educated bubble conversation. The tech sector has produced myriad companies that operated for years without revenue that eventually went blockbuster: Google, Amazon, Facebook, etc. Revenue, then, is only part of the equation. The trick is to figure out what else matters.

Intrinsic Value is defined by economists as the current and projected future value, marked to the present, of an asset. It is the “actual” value vs. the “market” value (and, thus, Facebook’s $1B purchase of Instagram is moot. That is a market value). This also means that if revenues are currently at zero, but future revenues are projected to be high, the current valuation is positive. So, then, despite zero present revenues, a company can have intrinsic value.

Opinions vary, however, on how to calculate this intrinsic value, since it relies solely on unknown future revenue. Is it the next instagram? Or a failure? It could be either. Mark Andreessen suggests factoring in the likelihood of the big win, thus adding a percentage multiplier into your calculations.

So let’s do that.

It is my position that many, if not all, of these companies are projected to earn their revenue from advertising. There are exceptions, like Zynga, but by and large, most of these companies are expected to make their money off of advertising. I have written extensively in the past about the finite size of the global ad market, and how we can only support 9 more google-sized companies.

There are about 3,500 startups funded every year. Delve into the stats at that link and you’ll see 1,000 of them are new startups in internet or media. The online ad market in the US is about $40B. The math there is $40 million potential for each new startup (you could complicate this by saying 5,000 startups over, say, five years, and $200 billion over the same span, but the math is the same.) And this ignores the previous contenders. What, really, is the statistical chance that any new startup will capture a substantial portion of that market? Given the massive barriers to entry via the need for building a substantial user base, and the large, incumbent players who already capture that ad revenue (Google is not going to go away), statistically, the answer has to be that It is approaching zero.

That should be the end of the argument from a mathematical perspective. The “rational” future “actual” value is the potential future value multiplied by its likelihood. I contend that the potential is far lower than stated, and the likelihood is far lower than stated as well. It’s not a $40 billion times 10%, it’s $40 million times .01%.

So there we have it. Mathematically, prices are out of whack with intrinsic values. And there is considerable disagreement, i.e. “considerable variance.”

There really shouldn’t be any thing else to the argument. However, I concede that all of this, while based in data, statistics and fact, is still based on my opinions of likelihood. There is still some guesswork.

Let’s look at the counter arguments.

 

The Arguments against it being a bubble:

There are a bunch. Let’s go through them one by one:

“This time it’s different”
There is a strange paradox going on with some observers contending that no one’s saying that this time things are different, while actually, this time, people are saying it’s different. Henry Blodget just gave us the best example of this. “Is everyone justifying today’s prices by saying ‘this time it’s different?’” he asks? “No.” And yet, right after saying that no one was saying ‘it’s different this time,” 15 slides later, Blodget is outlining why it’s different this time. It’s kind of awesome.

Paradox aside, Blodget’s arguments for why it’s different are the same as many others in the anti bubble camp: that way more people use the internet than during the dotcom boom, so the valuations are more realistic. That we are undergoing a social revolution, and that we are undergoing a mobile revolution. All of these are true. All of these are irrelevant to the existence of a bubble. They are arguments on one side of the “considerable variance” debate. Personally, I hope they are true. But we are sticking to the actual definition of a bubble here, and the fact that it’s different is moot. Indeed, both Schumpeter’s creative destruction and Peres’s technical revolutions, imply that many bubbles do result in something different, in a leap forward. And yet, the bubbles still happen, as do their commensurate crashes.


“Bubbles can be good.”

This is true. Bubbles can be good. They are still bubbles. The benefit of bubbles are moot to whether or not a bubble is happening. “Are we asking if consumer web/app technology’s impact and influence on mainstream culture and ordinary people will decrease? I can’t imagine so,” Anil Dash commented on Branch. It is an important point. Bubbles do destroy value, but good things can come out of them. This is probably more about the internal morality debates that many of us in tech have – are we helping the economy or hurting it? We may well be helping it, but it will still be a bubble, and someone else will bear the cost.

Nowhere in the definition of a bubble does social good enter into the equation. Carlota Peres predicates her whole seminal book on the fact that bubbles drive all major innovations. They do, however, come with costs, which she outlines in gory, devastating detail.

“Prices are in line with value”
The Public Markets are Fine, For now. Investor Chris Sacca colorfully sums it up: “As you guys know, I am also a very active late stage investor. Business on that end is entirely different than in the 90s when I first got to the Valley. Facebook, Twitter, LinkedIn, etc are all real businesses with CAGRs that would make a hockey stick blush and reach for the Viagra.”

Blodget points out that the IPO market is open, but it is far from robust. This is true. The bubble is not in public markets.

Yet many bubble deniers continue to use public market data to defend the private markets. Investor Chris Dixon does so in the Branch debate by saying, “In particular, in every bubble in the past, P/E ratios of securities bought and sold by non-professional investors were way higher than the historical average. During the dot-com bubble and housing bubble, P/E’s were over 40…. Current P/Es in tech are a reasonable 17 (historical average for S&P is 15).” Blodget uses Apple as an example, showing that it’s P/E ratio is a reasonable 15.

Mark Andreessen echoed these sentiments last week when he said “If we’re in a bubble, it’s the weirdest bubble I’ve ever seen where everyone hates everything. If you check tech stocks that went public recently, it’s nose down to the ground. We’re now 15 years of flat stock market returns. That’s a weird bubble.”

And yet public markets are irrelevant unless we’re arguing a narrow bubble of public market tech stocks only, which no one is arguing. It’s a red herring.

Public markets are tight right now partially due to tech stocks doubt, but the main reason for the lack of IPO access is due to larger issues with the recession we are currently in, and slowly working our way out of. This will change.

Previously, I had commented on how as pressure for tech companies to IPO increases , the public market tightness will come under attack. This absolutely came to fruition with the JOBS act, and Blodget as much as gives up the game in his recent presentation in a footnote that says ”The JOBS act could begin to change this. Fingers crossed…”

So let’s move on, then, to where most bubble-believers argue that the bubble is forming, in the private markets. As we’ve said, the hardest part of bubble identification is figuring out whether the prices have decoupled rationally or not. Whether “intrinsic values” are still being considered. Many bubble deniers concede this, such as Chris Dixon, who said of early stage private companies “those have never been valued by VCs on purely financial metrics.” This is, of course, true, but could be interpreted to tacitly admit that pricing is not at “intrinsic value.” Of course, things still need to be “considerably at variance” and “high volume” to be a bubble, but this does effectively concede that things are not at intrinsic value.

There exists a large body of work explaining the apparently irrational yet defensibly logical pricing of tech startups – quality of the founder, mobile trends, social trends, competitive funding environment. If you look at something like this Quora thread, you’ll see a lot of talk about normal valuations, with some admissions that they are mainly guesswork. Indeed, it’s comical how many different Quora threads ask the same question in different ways. Poke around. Also often mentioned are whether the founder is still at their job, the quality of the founder, and whether they have a prototype. It’s worth noting that none of these three factors are related to the economic definition of “intrinsic value.” I’m not saying they don’t matter – they’re factors I base my own investment decisions upon – and god knows what ELSE we’re supposed to use. But nonetheless, they are irrelevant to economic theories of bubbles.

Chris Dixon recently conceded that “certain stages of venture valuations do seem over-valued, in particular seed-stage valuations and (less obviously) later stage ‘momentum valuations.’” He explains this by talking about the proliferation of seed stage investors who are investing in what they believe in (I would be one of those) and in the momentum stage by non-inherent-value decisions such as “VC’s who want to be associated with marquee startup names, the desire to catch the next Facebook before it gets too big, and the desire of mega-sized VC funds to “put more money to work.” He counters this by saying that Series A seems under-valued. Dixon rightfully points out that it’s hard to have a public debate about this due to confidentiality. He’s right. So basically Chris is saying there’s froth in early stage due to lots of angels (like me) and froth at the late stage because of “momentum” valuations (ie tumblr and foursquare, groupon etc). In the middle, around Series A, he thinks that there’s not frothy valuations. He may be right. So can it be a bubble if there’s a sober moment in the process from early stage, to series A, to “momentum” valuations? It’s an interesting point of view. I do wonder, though, If there’s froth before and after sober Series A, however, does it really matter? And for what it’s worth, personally, I have seen plenty of froth in Series A as well.

One thing I will cave on. Dixon makes the excellent, eye-opening point that “This doesn’t mean the investors think they will invest and then get some greater fool to invest in the company again. For instance, at the seed stage, intelligent investors are quite aware that they are buying the dream but will need to have numbers to raise a Series A.” I admit I hadn’t thought of that in exactly that way before. Yet if our bubble is in Social Mobile, a world still primarily of light revenue, I wonder what metrics those valuations are based on? Revenue is, after all, the only metric relevant to “intrinsic values.” But most Series A rounds I’ve seen are still very light on revenue. The metrics used to establish value are based on users, who will, hopefully, one day be turned into revenue. Most of those valuations are, in my experience, fairly optimistic about per-user future revenue.

Andreessen’s method of market potential multiplied by likelihood does a good job at addressing these concerns. Though as we’ve seen, interpretations of the numbers can vary widely.  And none of those, however, work in situations like YC’s new “Apply without an idea” program, or the funding of some founders without any idea (i.e. Jakob Lodwick)

I’ll admit that we can’t get anything off the ground if we fund everything at zero or near zero valuations. We have to put a stake in the ground somewhere. But in terms of a strict definition of a bubble, it’s hard to deny that intrinsic value, from an economist’s point of view, hasn’t been thrown out the window.

In a recent controversial (in tech circles) NY Times piece by Nick Bilton, Paul Kedrosky,  an investor and editor for Bloomberg, explained “It serves the interest of the investors who can come up with whatever valuation they want when there are no revenues. Once there is no revenue, there is no science, and it all just becomes finger in the wind valuations.”

Chris Dixon partially affirmed this last week by saying “The argument that sometimes startups get better valuations without revenue is somewhat true.’

In the end, it’s anyone’s guess. Investor Chris Sacca sums up the conundrum on the Branch debate by saying “It’s easy to moan about valuation creep on the seed stage deals, and I cringe at some of the entitled attitude I see around these days. However, for all the whining, I will concede that two of my best performing deals ever, Twitter and Instagram, were done at roughly $25mm and $30mm pre respectively. So, what the fuck do I know?”

It’s a mess. It’s a constant debate. But if we can’t know prices are too high, we certainly can’t know that they’re reasonable, and, thus, the defense crumbles.

The “greater fool” inversion.
Bilton, who was on the Branch thread, parries for the bubble believers: “One of the signs of a coming bubble could be seen with the high valuation of start-ups. Viddy at $370 million; Foursquare at $700 million; Pinterest at $1+ Billion. All of these companies, and many others, have very little, if any, revenue. When start-ups reach such high valuations, they are left with only a handful of suitors that can acquire them. If there is no buyer, these companies have to go public, which is where the price-earnings ratios become a problem and confidence can wane.”

To which Michael Arrington shot back “A lack of buyers is an excellent indicator of a not-bubble. The greater fool theory assumes there’s always someone dumb enough to pay more.” Apparently because the number of buyers is limited, the greater fool theory is not in play.

I love this. The flaw here is that the whole point of the greater fool theory is that this is true until it’s not. One day the music stops.

Barring that, Bilton is correct: pressure is coming to push these companies public, before their ready (see below), thus, the “greater fool” argument is still in effect.

As an aside, Economists do not currently find the “greater fool” theory to be true, despite such believes being “prevelant among practitioners

“No one is getting hurt.”
The argument here is that this is just a bunch of rich people gambling, it’s only in the private markets, and no one else is getting hurt. Your mom and dad aren’t going to get hurt.

This is so not true. Public pension funds have always been a massive source of venture funding. Says the Times recently, for example, “By September 2011, retirement systems with more than $1 billion in assets had increased their stakes in real estate, private equity and hedge funds to 19 percent, from 10.7 percent in 2007, according to the Wilshire Trust Universe Comparison Service.” Even in staid Europe, Pensions makes over 10% of the VC funding, The Economist points out.

Your mom and dad can still get hurt. This is not just rich people’s money. Not even close. It may ease our conscience to think that, but it is a lie.

Low costs in early stage startups
Paul Kedrosky made a point in the Branch debate I had not thought of before in terms of bubbles, and it’s an interesting one. “There does seem to be more activity at the early-stage than is justified by outcomes, & it is frequently happening at higher valuations than would seem prudent. Having said that, the costs are low, so, in the same way the Cambrian explosion led to most modern forms of life, cheap speciation (with high die-offs) is an unsurprising ecosystem response to incident energy..”

Basically, yes, values are high relative to intrinsic values, but startups are so cheap now that it doesn’t really matter if a bunch of them die off. Good will be done.

To me, this seems to be a combination of the “bubbles can be good” argument and the “no one is getting hurt” argument. I’ve tackled each individually, and should point out that  both are specifically not relevant to the definition of the bubble, and in aggregate, damage may still be done if capital is being diverted from other, more useful sources. Recall the recent Tweet heard round the world by ex-Facebooker Jeff Hammerbacher, as highlighted in a recent Business Week article that expounds upon this point: “”The best minds of my generation are thinking about how to make people click ads. That sucks.”

There you go.

 

Why I think we are confused.

So what the hell? Seed stage bubble, rationality at Series A, then bubble again in “momentum.” Bubbles can be good. It’s gambling but it’s not. WHY DOES ANY OF THIS MATTER? It is easy to get confused. And here, I think, I would like to introduce some new factors into the debate.

We’re carrying baggage from last time

Many debates refer to “1999 style bubble.” NASDAQ insanity. Billions (Trillions?) of dollars vaporized. Our parent’s savings decimated. The dream of the internet halted. It hangs heavy over all of us. Many of us learned about bubbles for the first time (for my part, dating a Texan in college, my first real world experience, after studying bubbles in college, was the late 1980’s Texan real estate bubble). Much of our understanding of bubbles comes from NASDAQ’s rise and fall. The layoffs. The irrational exuberance. We are attempting to pattern-match.

But what if we are pattern-matching only the trappings of the bubble. We’re trying to avoid repeating our past mistakes. We speak of revenue in companies, though it is economically irrelevant to a bubble. Investor Dave McClure sums this line of thinking up when he says “there is SUBSTANTIAL revenue and even profits being generated by a much larger # of companies than ever before.”

We talk about P/E ratios of public companies. Ditto. We talk about how the economy as a whole is depressed, NASDAQ isn’t rising to the stratosphere. Though we felt and remember these things viscerally, they are all irrelevant to economic theory. We are addressing old criticisms when debating a current topic.

We also use the word “Bubble” to talk about all the cultural ridiculousness from the dot com era. Stupid parties. Bankers as tech moguls. 12-year-old founders. There was a lot of silliness in the dotcom era, and some of that silliness is happening now. This is neither evidence of a bubble or evidence against. But boy, does it bring back bad memories.

When we debate what’s actually going on, now, however, we must strive to remove all of that from our thinking.

Some people have an interest in milking it

I don’t want to spend too much time on this one. It’s tacky. And I don’t want to attack anyone personally. But remember: many people, including myself, are heavily invested in this trajectory continuing for a good long while, and getting a ton of these companies to IPO. Would a newspaper man be impartial talking about whether the newspapers are dying or not? Would a screen printer have an impartial opinion on desktop publishing? I’m not interested in going ad hominem, but there exists a substantial economic body of work around economic signaling and markets.

It’s early in the bubble

In his recent presentation, the multitude of slides Blodget shows of industry trends now vs. the dotcom bubble look, on first blush, as if they are different. The massive, spiraling peak we see in any chart of a bubble, ex post facto, hasn’t occurred yet. Yet if you look at 1997-1999 and compare it to 2010-2012, they are eerily similar. Bubbles start, grow, peak, and bust. That whole cycle is a bubble, regardless of where you are on it. Is this bubble early? Late? I’d probably wager we’re maybe a year or two in and it’ll peak in 2 or 3 more. But it doesn’t matter. That whole journey is the bubble. And I believe we’re in it now.

Words, words, words.

You’ll notice a lot of people saying “Boom” lately. Blodget, after saying there’s no bubble, throws in the word “boom” at the end of his presentation. MG Seigler starts the Branch.com conversation with “It’s boom times, yes.”

In economics, a bubble consists of a boom, and then a bust. That’s it. Boom sounds nice, boom times, boom boom boom. Booms come with busts. Within a specific industry, booms plus bust equals bubble. End of story as far as economics go.

“Boom times,” the fun one, conjuring images of the wild rest or a factory towns or smiling Wired covers, are associated with the economy as a whole. These booms also go bust, but it’s a longer economic cycle than a bubble, so it sounds less threatening (though paradoxically potentially far more damaging). It’s semantics, and irrelevant to the larger conversation.

There’s not a lot we can do about it

This is, basically, true. There’s probably not much we can do about it, except for talk about it, hence, the endless debate. Matthew Ingram from GigaOm says on the Branch thread “But is cynical gambling behavior in tech or startups any different from what happens in the stock market or any other market every day?”

Gambling comes up often these days when talking about tech. There is substantial economic debate and theory going on about whether the stock market is gambling or not at this point, and it’s an interesting discussion. The strongest traditional argument is that value is created in the stock market, and gabling is zero-sum. This is still probably true (though, again, there is debate about this on a macroeconomic level). Some economists believe that bubbles can create value over the long term (Peres) but they are still bubbles, and there are still losers.

Additionally, sticking to our common definitions of gambling, all this does is reinforce pricing is against intrinsic values.

It may not matter

MG Seigler on Branch says “All boom times end eventually. But calling this a ‘bubble’ implies this time is going to ‘burst’ with far reaching consequences. I just don’t see that.”

This may be rational. Most economists agree that bubbles can cause economic damage and are interested in discovering why they happen. But most economists also agree that there are benefits (Peres, Schumpeter’s “Creative Distruction,”) etc. It’s irrelevant to the “are we in a bubble” debate, but I believe that we all viscerally want to deny being in a bubble because we equate bubbles with the devastation wrought in the dotcom boom and the recent housing market boom, though those levels of devastation are not required for a bubble. Big bubbles take economies down with them. But bubbles don’t have to.

In 2007 or so the English synth pop band Depeche Mode was beginning work on their last album, Sounds of the Universe. By this point in their storied career, Depeche Mode had sold over 100 million albums. Their 8th album had gone platinum in the US and number one in eight major countries. Their 7th had gone triple platinum. They had some cash and they were going to put it into their new record.

Toward that end, Martin L. Gore, the primary songwriter in Depeche Mode, decided that he wanted some new gear. Not new, exactly, but rather old, vintage analog synthesizers (along with a boatload of guitars). And he wanted a lot of them. Said the engineer on the record Luke Smith, “Martin was buying all of the kit he’d ever wanted, along with any new and experimental gizmos that tickled his fancy. We started with a lot of gear, and by the end of the session there was a veritable smorgasbord of devices available to satisfy any palate.” Martin even credited the spree to the sound of the record: “I don’t think we can play down the effect that the parcels arriving every day had on the record.”

He was, to quote musician and analog collector Sean Drinkwater, “buying up every Steiner, EMS and EDP synth in existence.” Anyone shopping for analog synthesizers noticed that many of the Ebay auctions were ending in higher-than-normal prices. The specialist online sales outlets were all sold out, and synth prices skyrocketed. Frenzy ensued, and prices continued to skyrocket. Eventually, Depeche Mode got all the synths they needed, and prices began to decline.

And in the end, unless you were a synthesizer collector, the whole thing did not freakin’ matter one bit.

We learned our lesson last time

Many people believe that the tech sector has been sufficiently chastened and are more careful this time. Dave McClure says “The far greater trend is towards more rational co’s & pricing compared to 10-12 years ago.”

I’m tempted to say, “Irrelevant! Bubbles have strict definitions!” But in actuality, there is some validity for this point of view. Some economists agree. Studies have been performed where “bounded rationality” (the limits of investor’s knowledge) is mitigated over time with learning.⁠1 The studies were done with repeated trades with personally-known participants, but it’s not completely irrational to say that we’ve learned from the past bubble and may not make the same mistakes again. I hope so. It does, however, remain to be seen, and economic theory has not performed similar studies in the real world where people don’t really “know” each other. As an aside, there’s some interesting potential here on what it means to know someone, via social media and blogging, but I digress.

The Sustainability question

On the Branch debate, McClure nails it when he says “the more relevant issues to discuss are: (1) are there companies at incubation, seed, series A/B/C, or pre-IPO being ‘overpriced’ by investors, (2) is that happening at an ‘unsustainable level’ (ie, at some point will it be re-priced lower), and (3) is the trend towards more or less of that occurring now or in the future?”

He concedes points (1) and (3), so (2) is the big one.  Is it sustainable? Right now it can feel that way.

But things are happening.

We’re in a depressed economy, and VC is the one place exhibiting big returns. An analyst friend of mine says that the Instagram deal and the Facebook IPO are causing a frenzy with hedgies and high net worth individuals. And here I must apologize for bringing up Instagram. I agree with Chris Dixon that the Instagram deal is irrelevant to the existence of a bubble, and indeed it was a market price, not a valuation price so economists would agree as well. But the fact is rich dudes not in tech are freaking out over it. They are blown away by the breathtaking speed of wealth creation from the deal – who wouldn’t be? Many people on the Street are saying that that deal turned heads in a way even Facebook hadn’t. More money is coming into tech because of Instagram, whether it evidenced a bubble or not.

So what happens if the JOBS act, Instagram envy, a rebounding economy and the Facebook IPO concoct a perfect storm and cause a giant amount of new capital to flood the VC market?  Will prices stay the same? Or will we see an accelerated upward spiral? Will they still be sustainable then?

Are any of those four things NOT going to happen? We’ll have to see with the Facebook IPO but if all goes according to plan, this bubble could well be kicking into high gear.

We Believe in the Internet

The internet has massive potential. I believe this. We all do. We don’t like to call it a bubble because doing so belittles the transformational power of the internet. It makes the layperson go “Oh, just ignore that, it’s a fad.” The internet is not a fad. I believe that. Anyone in tech believes that. It’s why, despite everything I write here, I continue to invest in early stage internet companies (and, I confess, I may be a bit susceptible to the greater fool theory).

No one wants to beat on their baby. We love the Internet. All this talk of a bubble makes people doubt it. We don’t want people to doubt the Internet. For many of us, it’s the future. We remember people belittling the Internet after the dotcom bust, and it stung. Promise unfulfilled. It is very, very hard for me, at least, to talk about tech being hyped, because I love it so. It requires unrelenting intellectual honesty, and I can’t deny a massive amount of anxiety saying these things when I think about my own overwhelming exposure to tech in my investment portfolio. But I must. It sucks for me to say it, and I am not acting, yet, with my personal investments because of my belief that we are in a bubble, but I should. As much as I hate that. In the end, even though I see it coming, I’m gonna try and time it as much as anyone. Because I love the Internet, and I don’t want to get out.

1 King, Ronald R.; Smith, Vernon L.; Williams, Arlington W. and van Boening, Mark V.
“The Robustness of Bubbles and Crashes in Experimental Stock Markets,” R. H. Day and P.
Chen, Nonlinear Dynamics and Evolutionary Economics. Oxford, England: Oxford University Press,
1993,

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