April 8, 2017    4 minute read

The New Bubble: Tech Valuations

About to Burst?    April 8, 2017    4 minute read

The New Bubble: Tech Valuations

The social media era has introduced a simple concept in business: the value of community. It means that investors are willing to spend money (often in large amounts) to buy, or finance, platforms containing a huge number of users, even if the underlying business generates low inflows or none.

This new euphoria that has sprung up from Silicon Valley and now reached every part of the world is building an enormous market ready to blow up. On the other hand, everyone is free to value anything at the price he or she prefers and then buy it for the value he or she thinks is fair.

However, there is only one place where every inefficiency is eliminated and every non-profitable business takes what it deserves eventually, and that is the Stock Exchange Market. It is the representation of fairness and meritocracy, which rewards good guys and punishes bad ones. If a listed company is over or undervalued, it gets its fair value. Eventually, this is the rule. Thus, if a company has a poor bottom line over time, its share value goes down leading the companies to zero.

The issue is that looking at the figures we can easily understand how most companies that are a part of this “value of community” mechanism have nothing more than a huge amount of users, suggesting us that, sooner or later, they will default if they do not turn the community into a profitable business.

The Case of Snapchat

Snapchat was born at Stanford University in 2011 when Evan Spiegel presented the concept for a mobile app that deleted photos and texts after displaying them. His classmates baulked and thought the idea could not work.

Five years later, Snapchat has become one of the hottest social media apps worldwide and refused a $3bn takeover offer from Facebook. Bloomberg reported in June 2016 that it draws 150 million daily users, compared to perhaps 140 million for Twitter.

This story sounds like the fairy-tale of every single start upper that, starting from an office in a garage, ends up running a business which goes straight to the top of the rankings. But there is more.

In the past days, Snapchat has raised awareness in the eye of the public because of its IPO, launched on Thursday 2nd March and which has been the most massive one since the Alibaba Group. Snap Inc, the company that owns Snapchat, has sold 200 millions shares raising $3.4bn in total and seeing a valuation of $25.54bn.

Going Up

Before the launch, the price was set at $17, already higher than the expected range between $14 and $16 but, once launched, it rose, even more, reaching an intraday value of $26.05 and, after some ups and downs, stabilising at $22.72.

According to financial principles, those prices simply mean that Snap Inc should be a healthy and cash-generating company which will create value for shareholders.

However, looking at the data, it is extremely clear that the company is very far from generating profits that would justify a market capitalisation of $25.54bn. The reason for such a high valuation could be investors’ expectations of a strong growth with a brilliant future for Snap.

Once again, the data says something different. Indeed, the number of users has declined by 40% since the launch of Instagram’s Stories, and this is not exactly what should be called positive expectations regarding growth. Moreover, Snapchat is part of the “community value” mechanism which is user-based, and a decrease in number of users should have resulted in lost credibility, affecting the company’s value and investors’ decisions.

But what happened so far is completely different: investors have been scrambling to invest their money in Snapchat, consequently raising its share value ($25.54 bn), showing the irrationality behind the community’s value mechanism.

The Bubble

Snapchat is only one example of irrational euphoria that has hit business at our times. A sense of euphoria which looks more at the number of users than at the bottom line of a company.

The same euphoria which is leaving Twitter and causing its decline and that has forgotten the simple and basic concept of creating value. The euphoria led by the community value mechanism.

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