The good news is that we are nowhere near 1999 levels in terms of Internet company hype and excessive valuations. The bad news is that we are seeing the same types of froth, just to a lesser degree, that we saw back then. More than a decade ago we were wondering how Yahoo (YHOO) was worth more than Disney (DIS) and the market eventually corrected that inefficiency (today's values: Disney $76B, Yahoo $18B). Today we see online gaming company Zynga (ZNGA) worth $8 billion ($1 billion in annual revenue) compared with a value of $5 billion for Electronic Arts (EA) ($4 billion in annual revenue). Monster Worldwide (MWW) has $1 billion in sales and a $1 billion equity valuation, versus LinkedIn (LNKD) which has similar revenue and a $10 billion market value. These figures are lopsided in percentage terms, but at least these Internet stocks aren't worth more than the country's bluest of blue chips.
Facebook's $1 billion deal this week to buy Instagram, a mobile photo service with no revenue, shines a light on another phenomenon that we saw during the last bubble; huge changes in valuations one day to the next without any change in business fundamentals. In the 1990's a company could issue a press release announcing they were going to launch a web site and the stock would pop 50 or 100 percent. The Facebook deal is not astonishing as much for its price tag as it is for the fact that just last week Instagram raised $50 million in venture capital money at a valuation of $500 million. In a few days, Instagram's value doubled to $1 billion without it doing anything on the business side to warrant that price. Can you imagine how giddy the VC folks who made that deal must be? It's almost unbelievable.
To put the $1 billion price in perspective, consider than Instagram has 30 million registered users who pay nothing. Facebook is paying more than $30 per user for the company. Facebook itself has about 850 million users and netted $3 billion in revenue from them last year. At the forthcoming IPO valuation of $100 billion, Facebook is being valued at just over $100 per user. Should three Instagram users be worth the same as one Facebook user? It's hard to see how. Now, I understand that Facebook is paying a premium to buy the company outright, so these per-user numbers are skewed by that fact, but still, it's the general trend of the numbers that seems unsettling.
Overall, the U.S. stock market has more than doubled from its 2009 low. The IPO market has been on fire lately and these Internet stock valuations certainly are pointing to the strong possibility that we have a mini bubble yet again. While I would never predict we will see a repeat of 1999, I do think market participants need to tread carefully with these new companies. The current environment might indicate that at least a certain part of the equity market is overheating.
Full Disclosure: No positions in any of the stocks mentioned, but positions may change at any time