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Emerald Group Publishing Limited
Copyright © 2011, Emerald Group Publishing Limited
Bubble trouble: is history repeating itself?
Article Type: Rearview From: info, Volume 13, Issue 5
A regular column on the information industries
By now, most readers will retain only hazy memories of the so-called “dot.com bubble” roughly one decade ago, which witnessed the market value of companies associated in any way with the internet rising exponentially only to crash back within a short space of time. Table I contains a small cross-section of such companies, covering the period from end-1998 to mid-2003 when the first signs of recovery appeared. As can be seen, the market value of the sample companies not only more than doubled during calendar 1999 alone, but valuations approaching, and occasionally exceeding, $100 billion became quite normal.
The following year witnessed a widespread collapse – bearing in mind that a 50 per cent fall wipes out a 100 per cent rise – although certain equipment vendors such as Alcatel continued to prosper. However, 2001 proved to be damaging across the board and, for the most part, 2002 brought only modest relief. Hence, by early 2003, internet-related companies were typically worth no more than they had been at the end of 1998, although the picture is muddied somewhat by merger and acquisition activity during this period.
It may be noted that the table contains primarily long-established companies because, being publicly-quoted, they could be valued at market prices, and that they were largely concerned with physical aspects of the internet. This reflects the fact that, in a world where dial-up connections were still the norm, improving the infrastructure for the internet was a more urgent consideration than creating content for its increasingly fat pipes. But “multimedia” and “convergence” were increasingly coming to the fore, and the prime example was the takeover – despite the pretence that it was a “merger of equals” – of Time Warner by America Online which (subject to regulatory permissions) created AOL Time Warner (AOLTW) in January 2000. At that point in time, AOLTW was worth $330 billion, but the one key aspect that it shared with other companies in Table I, and indeed with start-ups that had yet to make any profit at all, was the total disconnection between performance and market value. In effect, the doctrine was that the internet was the future, and hence bloated market values would be justified when the profits flowed in at some ill-defined future date.
Naturally, by late 2003 everyone of note had gone on record to say that they had learned their lesson and that a bubble of this kind would never be allowed to happen again. But markets are famously short-term in their behaviour and the 1998-2002 bubble was, after all, hardly the first of its kind in history. Hence there were some dissenting voices, although even they generally took the view that memories of this bubble would last for at least a decade. But were they right?
If one restricts oneself to the companies involved in 1998-2002, then the answer is clearly “yes”. Although Nortel Networks, for one, did not survive, most operators and vendors have struggled on, partly bolstered by strategic alliances and mergers. But they have become the dinosaurs of the internet, producing low-margin commodities in a fiercely competitive environment. The traditional providers of content have also struggled as the public increasingly apply their ingenuity to obtaining content without needing to pay for it. But the point about “bubbles” is that they involve new ideas, which is precisely why notional value on paper cannot immediately be turned into hard cash.
And it is happening again. Consider the following:
Social networking site, Facebook, which was founded in 2004, was valued at $50 billion in February 2011 on the basis of (privately-held) stakes taken by Goldman Sachs and Digital Sky Technologies. It had yet to declare a profit.
Micro-blogging site, Twitter, was said to be attracting the interest of the likes of Facebook and Google in early 2011 at an implied valuation of $10 billion although this has now been reduced to $4.5 billion.
Social gaming company, Zynga, was valued at between $8 billion and $10 billion in February 2011, whereas in late 2010 it was trading privately at a valuation of roughly $5 billion.
Discount e-mail service, Groupon spurned a $6 billion offer from Google in 2010. It is expected to float later in 2011 with an implied value of between $15 billion and $20 billion.
In February 2011, a three-year-old online music service (jukebox) based in Sweden called Spotify, was valued at $1 billion. The company makes its money from advertising and subscribers who pay for “premium” access to its music services such as listening to music through high-end mobile devices.
It is worth noting that until a company is floated, there is no market-based yardstick to determine its value, and there were equivalents during the dot.com bubble such as Google which was listed as a privately-owned company in September 1998 and floated only in August 2004, at which point it was worth $23 billion.
Table I Telecommunications and related companies: market values 31/12/1998-31/05/05
The valuation put on Facebook in early 2011 meant that it was worth more than Time Warner, Yahoo! and eBay. On the plus side, it is said to be the world’s most visited web site, but that is not the same thing as having a viable business model which can be expected to earn an above-average rate of return for its shareholders – ask those of AOL which is now the poor relation of Time Warner. And the phenomenon of the market value of dot.coms rising above that of established, profitable companies was, in retrospect, the obvious sign that a bubble existed last time around.
But so many investors are piling into Facebook, Twitter et al. that there must be a belief in some quarters that this is “the future of the internet” rather than a bubble, so how to check? Ask as follows:
Does the start-up have a plausible revenue/profit generating business model?
Will its market continue to grow rapidly?
Will competition sooner or later drive down growth and/or profitability?
In the short term, at least, companies such as Facebook, Groupon and Zynga are all set to grow rapidly and generate revenues in the billions of dollars. In contrast, Twitter’s revenues fall well short of $1 billion and its business model is less robust. In the medium term, the prognosis for most of them is debatable. On the internet, the volume of customers is critical because prices are certain to be driven down by competitive behaviour unless brand recognition is rock solid and so many customers are signed up early on that there is too little room left for rivals. That seems to be a positive feature for Facebook, but the Groupon model is easy to replicate and Spotify is in the music business which is, at best, precarious.
Overall, two conclusions appear to be in order. First, the current bubble is far more limited in scope than its predecessor which affected established as well as start-up companies connected with the internet. Second, while some bubble companies such as Facebook may well thrive, just as Google has done, because its business model is resilient, one cannot help thinking that the bubble is going to burst for the majority.
Peter CurwenVisiting Professor of Telecommunications at the Department of Management Science, Strathclyde University, Glasgow, UK.
1. A much larger sample is to be found in Curwen (2002).2. See Curwen (2000).
Curwen, P. (2000), “Hey Presto! How to turn monopoly money into real money with a wave of the magic merger wand”, info, Vol. 2 No. 4, pp. 379–90
Curwen, P. (2002), “Assessing the meltdown in the telecommunications sector”, info, Vol. 4 No. 2, pp. 26–38