Musings On Markets

15 billion for Snapchat, a mind-boggling quantity for an organization that is desperate for ways to convert its reputation with some users (like my girl) into revenues. While we can question whether extrapolating from a small VC investment to a complete value for an organization seem sensible, there are two trends that are incontestable.

The first is that estimated ideals have been climbing at exponential rates for companies like Uber, Airbnb and Snapchat. In capital raising lingo, the amount of unicorns is climbing to the point where the name (which suggests unique or unusual) no longer fits. The second is that these ongoing companies seem to be in no hurry to go public, departing the trading in the private sharemarket space. These increasing valuations in private marketplaces led Mark Cuban to declare the other day that this “tech bubble” was worse (and can end a lot more badly) than the last one (with dot-com stocks).

There are other indicators that also support the argument that is not just a technology bubble, since a bubble occurs when market prices disconnect from basics. Unlike the 1990s, the marketplace capitalization of technology companies in 2014 is backed up by operating figures that are commensurate with value. One way of measuring whether a sector is in a bubble is if it accounts for a much larger share of overall market value than it delivers in revenues, earnings and cash flows.

In February 2015, technology companies take into account about 13.84% of overall organization value and 19.94% of market capitalization and they hold their own on nearly every operating metric. R&D, 17.93% of operating income and 16.46% of EBITDA, all higher than tech’s 13.84% share of organization value, and 18.65% of net income, close to the 19.94% of overall market capitalization. On the money flow measure, technology firms account for almost 29% of all cash moves (dividends and buybacks) returned to investors, higher than their talk about of market capitalization.

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To provide a contrast, in 1999, at the maximum of the dot-com bubble, tech firms accounted for 30% of overall market capitalization but delivered significantly less than 10% of net gain and dividends & buybacks. That was a bubble! Note, though, that is not an argument against market bubble but one specifically against a collective tech bubble. If you believe that there is a bubble (and there are reasonable people who do), it is either a market-wide bubble or one in a particular section of the tech sector, say baby technology or young technology. In my earlier post, I broke tech companies by age and mentioned that young tech companies are richly priced.

The private share market has made strides within the last decade in conditions of liquidity. NASDAQ’s private market allows rich investors to trade positions in privately kept businesses and there are other ventures like SecondMarket and Sharespost that allow for some liquidity in these marketplaces. To those who would argue that liquidity is skin deep and can disappear when confronted with market meltdown, you are probably right, but then again, why is you think that public markets are any different?

Low Float: The proportion of the stocks in these businesses that are traded is only a small proportion of the entire shares in the business. Just to illustrate, only 10.5% of the shares in Box, the latest technology listing, are traded on the market and small swings in disposition in the forex market can translate into big price changes. Here today, ignored tomorrow: The young technology space is crowded, and holding trader attention is difficult. The end result is a straightforward one. The liquidity in technology companies in public markets is uneven and delicate, with heavy trading in high profile stocks, in good times, and around profits reports masking insufficient liquidity, especially when you will need it the most.

While Mark Cuban concerns about the illiquidity of the private share market, I am uncertain that it’s any longer illiquid than the public marketplaces in dot-com shares were in the 2000, as the market collapsed. Intuitively, his contention is practical. With start-ups and incredibly young companies, it is a pricing game, not a value game, which price is defined by disposition and momentum, rather than fundamentals (cash flows, growth or risk). If you fail to trade a secured asset easily, it would appear logical to assume that any shift in momentum or mood in this market will be accentuated.

If you bring them together in a private share market, you ought to have the elements for a more impressive bubble, right? My intuition leads me down the same route, but when there is a lesson that I’ve discovered from behavioral fund, it is that your intuition is not right always.