Bubble 2.0: Are we about to witness another technology crash?

29 May 2008

Bubble 2.0 video

‘Irrational exuberance’ was blamed for the dotcom bust eight years ago. In recent months, Microsoft paid US$240m for a tiny 1.6pc stake in Facebook, valuing it at US$15bn. Irrational exuberance? You decide.

Eight years ago the Nasdaq reached its highest point in history due to the surge in valuations of dot.com companies with little to show for themselves other than a cool-sounding name.

Investors got vertigo. Some US$5trn was wiped off the markets, businesses folded, thousands of people were laid off and it has taken the tech industry seven years to recover.

‘Irrational exuberance’ was blamed for this period of wild optimism.

Today, there is a new generation of internet companies that go under the collective ‘Web 2.0’. Sites like Facebook, Bebo, Twitter, Skype, YouTube and MySpace are the toast of the party.

In recent months, Microsoft paid US$240m for a tiny 1.6pc stake in Facebook, valuing it at US$15bn.

Irrational exuberance? You decide.

Bubble trouble

The date 10 March 2000 means little to most people. But it is a spectre to quite a few who lost their money, their jobs and still carry the scars. It was the date that the Nasdaq stock market peaked at 5132.52.

The party ended when investors, appalled at the dizzy heights of valuations, saw reality and got vertigo.

The market crashed and within two years US$5tr was wiped from the market value of technology companies.

During the past seven years, the technology industry demonstrated the creativity, adaptability and flexibility for which it is renowned and new technologies from 3G to high-speed broadband have unleashed another wave of internet fervour, termed Web 2.0.

This is a world where firms like Skype, Facebook, Google, Bebo and Digg are the king-makers with all to play for and much to lose. In recent months, Microsoft paid US$240m for a 1.6pc sliver of social networking site Facebook, valuing the two-year-old firm at US$15bn.

No one is saying ‘Bubble, what bubble?’ but Silicon Valley insiders like Robert Scoble say the dot.com era and Web 2.0 are like chalk and cheese.

“It is a different bubble. There is no retail money involved in this game. My dad can’t invest in Facebook,” he adds, referring to the small fortunes made and lost by regular folk when hundreds of dot.com firms were floating on the stock exchange.

“Is Facebook worth US$15bn? Clearly it’s worth US$5bn, but US$15bn? Hey, Mark [Zuckerberg] got US$15bn. God bless America!”

But what of the current recession? “The economy is starting to turn and the real growth is years ahead; recession is a temporary blot on Facebook’s screen. It’s playing for a much longer game than that.”

However, Scoble does think there are too many Web 2.0 companies out there and predicts a consolidation.

“I have a folder of over 50 web applications from different companies that I want to try out but I can’t get to all of those. If I can’t, and I’m paid to do this for a living, then the ordinary person on the street is never going to hear of any of these.”

Conor O’Neill, CEO of social review site LouderVoice, thinks a tech bubble is definitely happening right now and is optimistic about it: “I think the US is slap bang in the middle of another tech bubble and I think it’s a good thing.

“Historically, bubbles are when all the great ideas and grand plans are hatched and tried. You get incredible energy and innovation. The bust then clears out all the bad ideas like Boo.com and you are left with what is good.”

The huge valuation for Facebook is not the issue here, says O’Neill. “I find the investment activity in the US$10m-US$50m range to be far more interesting. It’s those little companies with fantastic ideas and great teams that will power the next generation of web businesses.”

Fergal O’Byrne of the Irish Internet Association (IIA), says Irish businesses established before the first bubble are still around and thriving, such as online payment firm Realex and e-learning player Riverdeep.

“With the original bubble, there were an awful lot of starry-eyed entrepreneurs setting up companies that would be the next Yahoo!, but few survived. Many blame the venture capitalists as much as the founders. The soaring valuations and spending on marketing with no business plan to underline was endemic.

“Microsoft’s huge payment for a little piece of Facebook seems irrational and does harp back to the old days. We were disappointed when we heard Microsoft paid such a huge sum for such a small slice. It must be convinced that the business applications of Facebook will deliver huge usage. Will it be around in five years? Most likely, but I still wouldn’t bet my mortgage on it,” O’Byrne says.

The local venture capital (VC) community in Ireland is still cautious, though it has raised €750m to invest in the next wave of technology firms, having invested €1bn over the past decade. “Most of our investments would be in software firms that can grow to scale, not in dot.com companies or because someone has a nice widget,” says Regina Breheny, director general of the Irish Venture Capital Association.

“Funding in Irish companies is at its highest now since 2001, but much of these are follow-on investments in existing companies. There is still a lot of work to be done in raising money to seed new start-ups. Venture capitalists are currently raising money but it’s debatable how much of these funds will go into new plays in the next five years.”

The cool factor

Pat Phelan, CEO of Cubic Telecom and technology entrepreneur with an investment of his own in Web 2.0 company Twitterfone, says many of these valuations are “completely nuts”.

“These valuations frighten me because you have guys like myself working our butts off to get where we are. Figures are being thrown around for dumb ideas – it’s make-believe.”

While Phelan is confident about his own Twitterfone service, a voice-to-text application for micro-blogging site Twitter that was completely self-funded by those involved, he laughs at the idea of VCs crawling out of the woodwork mere days after its launch based on thumbs-up from influential bloggers like Michael Arlington of Techcrunch.

“What is happening is companies are tending to sell for their coolness. I have experienced this with Twitterfone. A VC guy rang me this morning and said ‘I love it, you’re very cool, and you have great attraction’ – we’re a week old!

“I’m trying to say to myself, ‘We don’t need any money’, but if everyone is offering you a million, it is all well and good. It seems to be that the products are selling on how cool they are, rather than what they actually do.”

If thousands of Web 2.0 businesses are being valued on their cool factor, what’s the worst that can happen if they are not floating on the stock market like in the dot.com bubble days? “Someone will release these things that aren’t paying their way. Facebook has an estimated value of US$15bn and a negative cash flow of US$150m last year: if you drew on that tomorrow at an AIB branch, what would they be saying to you?”

Social networking expert Tom Raftery also sees the US$15bn valuation of Facebook as “ridiculous”, but says there may be some method in Microsoft’s madness.

“That was a competitive play; Microsoft wanted access to the advertising market that rivals like Google are currently dominating. The only logic to paying US$240m was to get Facebook valued beyond anybody else’s reach. Microsoft is in a situation where the licensing model for buying software is dying – software as a service is growing and there are loads of software applications you can get on the internet for free. Microsoft needs to shift its model radically and that’s why it wants to buy into Facebook and Yahoo!.”

“There has always been a valuation issue with software companies, whether they are valued too high or too low. Facebook’s valuation is based on the number of people who use it and the potential to sell into that vast user market,” notes Ray Walsh, senior development adviser with Enterprise Ireland.

The important thing to remember about many current web-based companies is they can enter into partnerships or be white labelled, says Walsh, pointing to Newbay, an Irish firm that provides social networking and media elements to mobile operators including O2 UK, Orange and Vodafone UK.

One thing Walsh is sure of with the current tech boom is that this time around, it’s different: “The barrier to entry in this space is smaller. This is both a good and bad thing but the cream always rises to the top.”

Show me the money

In recent weeks, Irish search marketing company Interactive Return was sold to Publicis Groupe for an undisclosed sum. At the centre of the deal was specialist mergers and acquisitions firm Results International, headed locally by Damian Ryan. He says that buying social networking sites purely based on potential advertising revenue could spell disaster.

“Firms completely reliant on ad revenue and nothing else must bring something else completely compelling to the table. Some 23,000 applications were launched by brands on Facebook last year. But when you look at apps launched by brands like Woolworth and Time Warner, they would have as little as five daily users. This doesn’t bode well for advertisers.”

Nevertheless, ‘monetisation’ is the new mantra espoused by social networking players. Bebo, which has 1.1 million local users in Ireland, was bought by Time Warner for US$850m in March.

Speaking at the recent IIA conference, the new head of sales at Bebo in Ireland, Philip Macartney said: “Our homepage has an average of 800,000 daily views. That’s the equivalent of eight times George Hook’s daily listeners. We’re hoping to drive monetisation through collaborations with brands like Nike.”

His colleague, Mark Charkin, head of sales at Bebo international, says that ‘social media’ is the monetisation strategy the company is driving. “We’ve come up with a platform for creating video-centric profiles which allow content owners to bring their content into the Bebo environment. They own the content, we provide the platform and they get to hold onto the advertising revenue.

“From Bebo’s perspective, it will drive a huge amount of legal content onto the site, as well as traffic. We have 200 media companies including the BBC, MTV and CBS involved in this and the next wave is to drive similar deals with music companies, magazines and newspapers.”

As questions still abound over whether social networking companies and Web 2.0 players have a viable future or will bring about another bursting of a bubble, there is scant attention being paid to how ordinary businesses can drum up revenues using these technologies.

Barry Meehan of Clonmel-based Worldwide Cycles revealed that his website, which he developed on a shoe-string by pulling together a clever combination of a blog he writes every Monday morning, a video page on YouTube and a Flickr photo gallery, has managed to turn his company into an internationally recognised brand.

“It has certainly spread the catchment area for customers far and wide,” he says.

“People make a point of driving to our shop in Clonmel. And because of the photos and the blog, they walk in as if they know us personally. And in many ways, they do. One video on YouTube led to a four-fold increase in sales of a bike-washing product. Last week, I sold a bike online to a gentleman in Italy for €3,000.”

If that’s not viable social networking, what is?

By Marie Boran and John Kennedy

Bubble 2.0 video