Why I don't believe in these crazy technology company valuations


The debate about the potential second technology bubble is all over the media. One of the first milestones that will determine the outcome of this story happened on friday, when Facebook went public. As opposed to other (smaller) web IPOs of the past years (LinkedIn, Groupon, Zynga, Yandex), the price on the first day stayed on the same level. This was to be expected, since Facebook received the valuation of 100 billion dollars. To put that in perspective, that's around half of Google's value, and about the same value as Amazon has. But Facebook makes 10 times less revenue than Google does, and its revenue growth is slowing down. Was Facebook valued too high? It seems so, and some analysts are already saying that most of the stocks were bought by institutional investors to keep the share price above 38$.

Facebook is not the real problem

But Facebook is not the biggest problem. It is the leading global social service, and an established company with almost 1 billion registered users, besides making quite a hefty amount of revenue ($3.7 billion in 2011). I'm more worried because of others, who make little or no revenue at all. Today, Rovio is valued around the same as Nokia, with yearly revenues of around $100 million. Instagram, with practically no revenue model, was bought for $1 billion, which is 12.000 times what Kodak is worth. A bit silly.

In technology, specially the web, companies come and go. The lifespan of services is short, and people don't hesitate to switch to a new, better alternative, and they switch fast. Remember Excite? Yahoo? MySpace? They were on top of the world not more than a decade ago. Draw Something, which was bought by Zynga for $200 million, already lost millions of users. How long does will it take for people to get bored with Angry Birds? Foursquare, Twitter, Pinterest, Instagram, even Facebook?

Still looking for a revenue model? Consider this.

Most of these companies have millions of users, and that is probably what fuels their valuations the most. Even though, quite a few of them are still looking for their revenue model. But what if the market simply isn't big enough for everybody? What if that is the real problem behind not being able to find a revenue model? I did some research, and here's what I found out:

  • the projected global spending on online advertising will be around 97$ billion in 2013 and $113 billion dollars in 2014 (source, source)
  • around half of that will be spent on search, around half on display (source)
  • projected revenues of social media ad spending in the US are around $10 billion in 2016 (source)
  • global mobile ad spending in 2016 will be around 15% of total online spending, or $22 billion (source)
  • apps and in-app purchases will generate around $46 billion in 2016 (source)
  • estimated size of the virtual goods market in 2015 is around $5 billion (source)
  • Google makes around $40 billion a year (source)

Perhaps I'm missing something, but these facts tell me that all of these companies have a market of around $150-$200 billion in 2015. ALL of them, including all the local players. Not really that much when you think about it. Sure, it's a different industry without production, but for comparison, Apple's yearly revenues are about $100 billion.

Trying to understand the math behind valuations

I went even further, and analyzed the performance of these companies; how much they earn, how much they are worth, and how many users they have. Then I tried to compare the price / sales, sales / users and price / users ratios. Since a few of high-valued companies basically have no revenue (Instagram, Foursquare), it seems that they are worth mostly between $20 and $100 dollars per user.

Sales ($b)Price ($b)Users (m)Price / SalesSales / UsersPrice / UserSource
Draw something0.050.2104.005.0020.00revenue, value, users
Facebook410090025.004.44111.11revenue, value, users
Foursquare/0.720//35.00revenue, value, users
Instagram/150//20.00revenue, value, users
Pinterest0.05*11220.004.1783.33revenue, value, users
Rovio0.191000**, value, users
Tumblr/130//33.33revenue, value, users
Twitter0.141010071.431.40100.00revenue, value, users

Data for publicly traded companies are available on MarketWatch.
* - estimate
** - downloads

Google manages to make the most from its users, around $40 per user per year. How much can the others make in the long-run, put together with the estimated $150b market size? How many can even earn anything before their users leave? The equation somehow doesn't add up.

These companies are great, but still…

I'm a big fan of the internet, I truly admire these companies, and use most if their services. But I still think this is madness. Didn't we learn enough from the first dot-com bubble? Today, we're a part of the social / mobile excitement, what can we expect tomorrow, the semantic excitement? The internet is maturer than this, and nobody will take it seriously, if it will behave so manically depressive. Ups and downs every few years surely don't work that well, and another bubble is definitely something the we don't need in these unstable economic times. So, please guys, take it a bit easier. don't be too greedy and enjoy what we have.

Perhaps the best thing that could happen at this point is for Facebook to lose about 30%-50% of its value. That could put some sense into the frenzy, before it goes to far. The situation surely needs more consideration.

You know what's cooler than $100 billion dollars? $50 billion dollars.

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written 21.5.2012 9:14 CET on chronolog
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