Post-Twitter IPO: Time to fret about a new tech bubble?

This much is clear: Things are getting frothy out there. But does the stock market's reaction to Twitter's IPO mean another tech bubble is forming?

Twitter IPO with Jack Dorsey, Biz Stone, Evan Williams, Dick Costolo
In the moment: Twitter co-founders Jack Dorsey, Biz Stone, Evan Williams and Twitter CEO Dick Costolo on the trading floor of the New York Stock Exchange on November 7, 2013. Emmanuel Dunand/AFP/Getty Images

The stories are legendary. Startups with no real business model and few prospects of building real companies went public in the late 1990s. Investors obliged, generating millions of dollars for corporate insiders, and before long, Silicon Valley had no shortage of firms bulging with cash and armed with little more than a pipe dream.

Then it all came a cropper. Interest rates rose, profitless companies burned through their cash piles and a nasty bear market set in. Stronger Internet companies like Amazon and eBay survived. Most of the flimsy concept endeavors like Pets.com and Boo.com flamed out, becoming footnotes in a lengthy literature of cautionary tales about the risks of speculation.

Fast-forward to the present. Twitter's IPO on Thursday got off to a stunningly successful start for the company and investors alike, while Facebook shares have recovered from their rockier launch last year, and that makes for two of the world's largest social networks trading publicly. The Nasdaq, meanwhile, is now at a 13-year high, multibillion-dollar valuations are being accorded to startups like Pinterest and Snapchat, and just yesterday, reports surfaced suggesting that Square, the mobile-payments service run by Twitter co-founder Jack Dorsey, will be filing for an IPO of its own .

Not surprisingly, thoughts have turned to the prospects for a new tech bubble.

According to PitchBook, a company that follows venture investments, 2013 has had more venture-capital-backed IPOs than any other year since 2000. Perhaps it's a coincidence but perhaps it's a harbinger.

The stark contrast of profit-taking and massive losses that resulted from the dot-com bubble bursting at the end of the last century still looms large in the minds of those who lived through it. And the idea that a company like Twitter has become such a hot option on Wall Street could scare those who still live with the dot-com burst's scars.

During the nine-month period ended September 30, Twitter generated $422.2 million in revenue , up from the $204.7 million it posted during the same period in 2012. Twitter's losses widened, however, jumping from $70.7 million last year to $133.9 million this year.

Twitter has also been criticized for its lopsided business. A disproportionate amount of its revenue -- 75 percent -- comes from the US. But 78 percent of its users are overseas. Twitter says that it makes $2.58 per 1,000 timeline views in the US. Internationally, that figure drops to 36 cents.

Losses and trouble generating revenue were hallmarks of the dot-com bust. A slew of companies went public, saying that the losses were the result of efforts to steal market share. Eventually, they would say, the profits would come. In far too many cases, they didn't.

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A belief in growth
Wedbush analyst Michael Pachter acknowledges that Twitter might, at first glance, look like a major risk, but there's far more to the company's value than profits.

"There are a lot of new(er) companies like LinkedIn, Facebook and Twitter that are growing revenues quite rapidly, and it's hard for most investors to figure out how profitable they can be, so we see techniques used to value them such as revenue multiples," Pachter said. "They appear expensive when compared to more traditional businesses, but the market clearly believes that many of these companies have a lot of growth ahead of them."

Indeed, social network investors have made out quite well. After its disappointing start that saw shares plummet following its initial offering, Facebook's growth in mobile and focus on revenue gains have helped the company's stock soar. This year alone, Facebook shares are up 85 percent to around $49. Facebook has reached as high as $54.83 per share, up from its 52-week low of $18.87.

LinkedIn has been an exceedingly successful investment opportunity. In the last year, LinkedIn shares are up 107 percent to around $220. The company's shares topped out at $257.56 earlier this year before settling.

Other dot-coms are seeing their shares soar on Wall Street as well. Priceline is currently trading at $1,058. Zillow, a company with its fair share of skeptics, due mainly to its paltry revenue figures and stiff competition, has watched its shares soar 184 percent this year, alone.

Stock appreciation, however, doesn't necessarily mean a bubble isn't forming. After all, companies with broken business models saw their shares soar in the late 1990s. Now they're defunct.

Some similarities between the dot-com bubble and today's market have started to emerge. One of the key reasons startups generated so much investor activity was the low interest rates of the 1990s. Investors needed to decide whether to put their cash in low-interest securities or take a risk on the higher returns offered by stocks. They chose stocks. With interest rates now historically low, a similar scenario has played out, as evidenced by the market's dramatic rise in the last two years.

Some questionable deals have also been inked. Pinterest, a company that is believed to be generating only paltry revenue, recently raised $225 million on a $3.8 billion valuation . Granted, the site is growing fast and its product-centric business model could eventually help it generate massive amounts of cash, but that hasn't happened yet. It appears at this point that VCs see Pinterest as the next big IPO -- and a quick money-maker.

Of course, Pinterest is one of many. Several popular services -- Tumblr, Snapchat, WhatsApp, and others -- have attracted investors with massive valuations, despite little or no revenue or chances of turning a profit anytime soon. Tumblr, for example, was acquired by Yahoo for $1.1 billion , despite generating an exceedingly small amount of revenue.

There is admittedly a lot of guesswork that plays into an investor's decision to invest in a company. But after the dot-com bubble burst, investors became more realistic and dropped cash mainly in those firms that could justify the investment.

Now, though, at least some companies are getting major investments because of their massive and growing user bases -- not their financial security.

During the third quarter, venture capital investments jumped 97 percent compared to the second quarter in the technology space, according to PwC. One-third of those investments were deals in excess of $250 million.

The good (and bad) for Twitter's user growth.
The good (and bad) for Twitter's user growth. S&P Capital IQ

"Private equity funds are increasingly active in the technology sector, and with growth a constant focus for technology businesses, we anticipate the abundance of cash at home and overseas held by corporate acquirers to spur deals in the months and quarters to come," PwC industry deals leader Rob Fisher said in a statement last month.

Analysts don't seem all that concerned. Gartner's Brian Blau, for example, said that there's real value over time in the companies that are receiving massive valuations.

"Maybe there are some inflated company valuations, especially in hot areas like social networks but I also think that their long-term value as yet to be really understood," he said.

Stay the course, Twitter
Blau is even more trusting of Twitter's ability to seal its fate. He says that as long as Twitter's management can keep the company on the same path, all will be fine, despite its continued losses.

"They have a strong and recognized global brand and they continue to do well with their advertising product," he said. "If Twitter can keep going down this track, and I believe they will, their post-IPO performance will be what investors are expecting."

BTIG Research also expressed faith in a significant upside to investing in Twitter. Many other analysts agree.

Whether Twitter will be success on Wall Street, however, doesn't necessarily address the question of whether a bubble is slowly forming. On that front, Blau seems convinced that, for the time being, we have nothing to worry about.

"I don't get the sense there is a bubble right now," he said. "I mean, the level of investment is nowhere near the levels from the 2000 bubble."

Pachter shares that sentiment. "I don't think that Twitter has anything to do with a bubble," he said. "There is a lot of demand for growth businesses in tech, and Twitter certainly fits the bill."

So, what's the takeaway? Venture capitalists and public investors seem ready and willing to bet on startups. The question remains, however, whether that seeming excitement will lead to industry success or one big, loud, pop.

One note: venture capitalists were surprisingly tight-lipped on the possibility of a new tech bubble forming. CNET contacted a number of venture capitalists, but none of them responded to our request for comment on Twitter's IPO or the possibility of a new bubble forming.

About the author

Don Reisinger is a technology columnist who has covered everything from HDTVs to computers to Flowbee Haircut Systems. Besides his work with CNET, Don's work has been featured in a variety of other publications including PC World and a host of Ziff-Davis publications.

 

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