IPO CONSENSUS: Web 2.0 not much different from Web 1.0

March 19 2014


Back in the old days, when companies went public (i.e. started selling ownership in their company by issuing stock), they were for the most part very well-run and profitable businesses. A funny thing happened in the late-90’s when a whole swath of companies mostly in emerging Internet “Dot Com” business, went public and had their stocks explode exponentially overnight. Companies like Pets.com, eToys.com, go.com, were valued more than most Fortune 500 companies. When you looked at their financials, most of them were not profitable. Heck most didn’t even have any cash or revenue coming in. Suddenly it didn’t matter if you were profitable. As long as you had “traffic” or “eyballs” on your business, you were golden. Investors couldn’t get enough of these IPO’s because for every eToys.com, there was a Netscape whose share price exploded. Then investors woke up in 2000, and discovered that you can’t create value from eyeballs. You need to have cash flow and durable profits to justify stocks that were trading with Price/Earnings ratos in the triple digits. The party was over and investors were royally burned. You would think investors would have learned from this low point? Apparently not.

In the last six months, we have seen a flurry of IPO’s. This time a new generation of mostly technology companies has emerged with new business models around social media (aka Web 2.0). Unlike the late 90’s, some of these companies are generating meaningful revenue and profits, led by Facebook, however an overwhelming majority of newly minted public companies have no profits behind them. According to Jason Goepfert, founder of Sundial Capital Research and author of the SentimenTrader Daily Report, “about 74% of companies that went public over the past six months weren’t profitable, the most since March 2000, when about four out of five new companies were money-losers.” The last time this ratio was that high was just before the above described tech crash in March 2000.

Unprofitable companies going public is not uncommon, since 1990, 42 percent of companies going public were not profitable. The parallels to 2000 are striking. Instead of placing value on profit, metrics such as “likes” and “poking” are deemed to be acceptable proxies. As in 2000, the market will wake up one day and realize they were punk’ed yet again. Yet again, innocent investors will be left holding the bag. Fool me once shame on you…and you know the rest.