Why “Bubble 2.0” isn’t going to burst

I'm excited to add a second guest blogger to the already bafflingly strong roster. Our intrepid guest blogger, AK47, has been gifted with Rain Man's intellect and Elvis Presley's charm. He can effortlessly squat thousands of pounds and conduct theoretical algorithmic research... at the same time. Long story short, you're going to want to listen to what he has to say.

- 44 Maagnum

There’s been some interesting speculation lately as to whether we’re in the midst of a second Internet bubble, one some have labeled “Bubble 2.0”. There seem to be a lot of naysayers questioning the $50 billion valuation of Facebook, or more recently the $10+ billion valuations of Twitter, Zynga, and Groupon. Some have claimed that these companies simply don’t have the cash flows to support this kind of valuation, that they aren’t on par with brick and mortar companies with similar market caps, and that greedy investors are simply repeating their mistakes of late 1990s.

Internet bubble

But this “bubble” is of quite a different style than the first. To me, these current valuations seem much more reasonable than their counterparts from the late 90s. We’re not talking about Pets.com—which investors sank $300 million into for a whopping first year earning of $619.00—we’re talking about Internet behemoths like Facebook, which already has 500 million+ users, and which saw annual earnings of around $800 million in 2009. Internet gaming mogul Zynga saw $250 million in revenue in ‘09. The biggest difference between the dot-com bubble and what’s occurring right now is that these current companies are actually generating revenue. These companies are household names, and are providing services that tens or even hundreds of millions of people worldwide use on a daily basis. The unbelievable followership that these companies hold mean they certainly aren’t the type of company that will simply vanish into thin air like many dot-coms did in the early 2000s.

I don’t mean to say that these valuations are spot-on—it’s probably next to impossible to predict how much Zynga is actually worth, or if Groupon can continue its current growth rate, but I will say confidently that these valuations won’t be the orders of magnitude off that valuations during the first dot-com bubble were.  There’s very little risk of Facebook simply going bankrupt overnight, or Twitter just closing up shop tomorrow. If their valuations are wrong following their IPOs, their prices will shift slowly-- similar to how the stocks of most normal companies vary.

That said, it’s still important to be wary of the kind of hysteria that was the downfall of so many investors during the first dot-com bubble. The fact is that for every successful new tech company, there are many, many more failed ones. Though some of the few that survived the dot-com era are now thriving companies (see eBay, Amazon, etc.), there were far more failures.  A key characteristic of bubbles is this type of hysteria, and so far at least, we simply haven’t seen that. It’s certainly debatable whether Facebook is worth $50 billion, $25 billion, or $100 billion, but it’s probably not reasonable to value it with a figure in the millions. That’s the major difference between this “bubble” and the last.

When the dot-com bubble burst, the number of new websites being founded plummeted, but that didn’t mean Internet usage or interest plummeted. The Internet was still growing, and we’re reaching a time now where more people are more comfortable with the Internet than they’ve ever been in the past. Average web users continue to be more willing to open up their wallets and dish out their credit card number to spend money online, and more businesses continue to see the benefit and feasibility of advertising online. And as long as that trend continues, there will be room for companies like Facebook, Twitter, Zynga, Groupon and others to be worth their billions.