Are We In A Bubble? Just Ask The Customers

Everybody knows the story: in the first Internet boom, new companies rode high on staggering losses only to face bankruptcy once the music stopped. At the height of the madness, a single Internet startup lost $720 million in one year, but was somehow valued at $25 billion.

Now as companies invent arcane financial metrics to create a sense of profitability without actually being profitable, investors are again clamoring about “fundamentals,” the term they use for revenues and profits.

But the most fundamental measure of a company’s success is whether the sources of its profit — its customers — happily part with their money. Customers’ happiness tells you as an investor that the company is not merely profitable or unprofitable, but sustainable.

There’s a big difference. A company that makes money can still be unsustainable. HomeAway had a soaring IPO, but the customers who use its site to rent vacation properties hate it. This tells you that one day a startup like Dwellable or Rentmix is going to destroy HomeAway.

LinkedIn on the other hand eked out only $1.81 million in profit last quarter, earning money at about the same rate as Redfin did in June. But LinkedIn is worth $9 billion. That’s because LinkedIn’s earnings are very sustainable — and Redfin’s earnings are, admittedly, still very seasonal. No company will replace LinkedIn as a professional network anytime soon.

Investors’ inability to distinguish sustainable companies like LinkedIn from trendy dreck is what drives bubbles as well as crashes. We talk about crashes as the return of rationality but in reality crashes are just as irrational. Yes, the NASDAQ today is at only half of its April 2000 peak, but it’s at double its September 2002 low. The broad, multi-year bet that Wall Street placed against the Internet post-bubble was fundamentally the wrong bet.

Already, history has repeated itself. Remember the wildly popular 2007 video, “Here Comes Another Bubble”? It mocked PayPal’s Peter Thiel for insisting there’s no bubble. As evidence of the madness, it then cited the valuations of Facebook at $15 billion (now valued at $100 billion), Skype at $2.6 billion (just bought for $8.5 billion) and YouTube at $1.65 billion (the best deal Google ever made, with traffic and revenues that just keep growing through the roof).

A year later, Sequoia’s “R.I.P Good Times” presentation — which argued after the financial crisis that “a v-shaped recovery is unlikely,” and showed a picture of a Depression-era soup-line — was mostly a death knell for itself. Since then tech’s recovery has been nothing if not v-shaped, and Sequoia has missed out on an explosion of early-stage opportunities.

Now in 2011, the stupidest conversation we’re having is whether we’re in a bubble or not. Rather than trying to figure out whether all companies are overvalued or undervalued, we should think about which ones are using disruptive technologies to solve a serious problem for a large group of customers. Those companies are almost certainly not overvalued.

Take for example that company which lost $720 million in a single year. It had the dubious honor of being the most unprofitable Internet company in 1999, but it turned out to be the most sustainable business the Internet has ever created: Amazon. Post-bubble Amazon was trading at $7.19; today’s it’s trading at $209. Does anyone think Amazon is wildly overvalued?


  • haydesigner

    “With continued strong growth and better monetization, Mahaney forecasts YouTube to bring in more than $1 billion in gross revenue and more than $700 million in net revenue by the end of 2011. That number was arrived at by comparing YouTube’s monetization with monetization at MySpace, while estimating 30 percent growth in 2010 and 20 percent growth over 2011.”

    While the revenue is (still) surprising to me, there have been no remarks about profitablility of the YouTube branch of Google. The costs of streaming all that video has to staggeringly high. Indeed, almost no one thinks they have actually made any profit on it yet. Almost five years later, and still an absolute ton in the red… I'd definitely hesitate to call that the best deal Google ever made.

    • GlennKelman

      Great comment. I've wondered about YouTube's profitability myself. But here's my counter. Which would you rather own in five years: NBC, CBS and ABC combined or YouTube? Google is one of the only acquirers that could have found a way to systematically lower streaming costs, so I believe YouTube is quite profitable now and will become more so over time.

  • haydesigner

    I would imagine that Google can work 'magic' on lowering some costs (mostly on the hardware and compression end), but they still have to pay delivery costs. And with more and more videos being added every single day, that cost is almost assuredly going up, not down. (Google doesn't actually own any internet pipeline, does it? I genuinely don't know.)

    I imagine their big revenue is *mostly* made from hosting content from corporations, but I also can't imagine it to be that impactful to the overall cost of the entire division. They are able to hide the day-to-day costs of YouTube because they  do not have to break out the numbers separately. As far as I know, Google has never talked about YouTube making a profit, or anything even close to a profit (indeed, most of what I recall reading post-aquisition was that Google was bleeding money from it… but it has been awhile since I've paid any direct attention). You would think that if it was, they'd be happy to trumpet that news. 

    As for your five year question, give me the Big 3, no doubt. They have content, profits, brands and proven track records. And will almost assuredly continue to make money, and more of it than YouTube, for then next five years. Now if you asked me about 20 years in the future… my answer would likely be different.

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  • Aaron Fyke

    Interesting – a very similar discussion happens regularly over at Fred Wilson's blog “A VC”.  Fred's contention is that valuations are abnormal now (although with positions in Foursquare, Twitter and Zynga, he's likely benefited from that).  I find the completely uncoupled relationship between various aspects of the economy to be really astonishing.  In the late 90's it seemed that internet valuations, property values, overall economic growth, and just about every metric was pointing up.  Now we fear a valuation bubble of early stage companies (mostly in the internet/software space – there's less of that talk regarding cleantech/biotech), we fear a real-estate market…crash? bubble? what? (It seems that everyone is just waiting), and our unemployment numbers have a long way to go.  Some things are going up while others are going down.

    “Interesting times” indeed.

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  • San Diego Mover

    Of course there will be a market of speculators. PE ratios have been off since 1983. As long as wall street can sell their greed to main street there will be stocks that are over-valued and under-valued.

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