Doubt Creeps into Tech Valuations

When people worry about valuations, Eric Schmidt likes to remind them about Google Inc. The Internet search provider made its stock debut in 2004 at $85 a share, a price tag many at the time thought outlandish.

Seven years on, that number has swelled to north of $500 and Google is the fourth largest U.S. technology company as measured by market capitalization behind Apple, IBM and Microsoft.

“Everyone said it was an unbelievably high valuation,” the company’s former CEO and now executive chairman told reporters on the sidelines of the annual Allen & Co. summit in Sun Valley, Idaho. “We underpriced!” he joked.

Trouble is, not every company headed to market this year or next—Groupon, ZyngaGame Network Inc., Facebook among them—may become a Google. And recent high-profile debuts have spooked investors by dipping below their IPO prices.

Chinese social network Renren debuted in May at $14 and was trading at about $10 a share in mid-July. VC-backed online music service Pandora, which launched its IPO in May at $16 a share, traded below its IPO price for several days before rebounding.

Some have no qualms calling the current situation a bubble, among them WPP Plc CEO Martin Sorrell. “Internet valuations are crazy,” he told Reuters in Sun Valley.

IAC Chairman Barry Diller, known for a willingness to buck conventional wisdom, also described technology stocks as “wildly overpriced.”

While underlying businesses at many of the companies, including Facebook, were solid, Sorrell still had doubts about the high prices they command. Investors expect Facebook to have a valuation of around $100 billion by the time it holds an initial public offering early next year.

Investor nervousness is mounting as U.S. economic growth begins to sputter. Early 2011 optimism—nearly 80% more was raised on U.S. equity markets in the first half than in 2010’s first six months—has given way to warnings of a second-half slowdown in the pipeline.

In the tech sector, such fears are particularly relevant given the dot-com crash of 2000, when the likes of theglobe.com, VA Linux and Marketwatch.com rose six- or seven-fold on their debuts, whipped into a frenzy by day traders. Many of those so-called bubble babies quickly burned through their proceeds and subsequently vanished, leaving investors holding the bill.

The U.S. Securities and Exchange Commission is now on the lookout for “bubble-era” IPO practices—such as pricing too low. A combination of first-day trading spikes and razor-thin yields on debt may foster an environment where Wall Street can take advantage of investor demand, SEC enforcement chief Robert Khuzami said in June.

LinkedIn Corp.’s 109 percent first-day surge even invited some criticism that its investment bankers might not have priced it high enough.

Others have expressed concern about private-company transactions on the secondary market—created to allow employees of unlisted firms to trade their stock. But Google’s Schmidt said analysts were extrapolating overall company valuations from sales of small slivers on secondary markets, which he called “mathematically incorrect.”

Recent trades on those unregulated secondary markets, for instance, have accorded Facebook—undoubtedly one of the most keenly awaited tech sector IPOs—a valuation of as much as $70 billion, scores of times its estimated annual revenue.

“If I have one concern, it is probably that secondary markets will end up needing some sort of oversight or regulation if something goes wrong with such lofty valuations,” said Jim Robinson, a partner at RRE Ventures.

Former Ning.com CEO Gina Bianchini said high prices were due to scarcity issues rather than irrational investor behavior.

“The IPO market has ballooned because there has been such strong demand from very small floats for social media companies” such as recently listed LinkedIn, she said.

Overall, many industry executives say the bubble is a figment of Nervous Nelly imaginations.

“You’re looking at companies with strong fundamentals not only blazing a trail and serving a market need but also generating cash flows,” said Steven Boal, CEO of 13-year-old Coupons.com, which recently raised $200 million, valuing the business at more than $1 billion.

“To me, that’s the anti-bubble.”

Reporting by Sarah McBride and Yinka Adegoke, Reuters