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Posted at 08:42 AM ET, 07/01/2011

The tech bubble is coming. Prepare yourself.

Word leaked out Wednesday that LivingSocial is preparing for a $1 billion dollar IPO. (LivingSocial co-founder Tim O’Shaughnessy is the son-in-law of Washington Post Co. chairman Donald Graham.) The Washington Post also has a marketing partnership with the firm. LivingSocial follows on the heels of its competitor Groupon, and other hot tech companies, namely LinkedIn and Pandora. That the door has finally opened to IPOs for tech companies should be a cause for celebration. This will provide these companies with growth capital, and give venture capitalists the exits they need so that they can start investing in the next generation.

But I am worried — really worried.

The valuations are inflated beyond reason, and there are clear signs of another technology bubble—just like the dot-com bubble, which, when it burst, caused an ice age in the technology sector. Venture capital firms lost significant amounts of money during that time, so they slowed down their investments. Technology companies were starved for financing, so they didn’t have the funding to bring their innovations to the markets. It took a decade for the technology industry to recover from the excesses of the era.

The problem is that both LinkedIn and Pandora are dramatically overpriced, and Groupon has an unproven business model. Yes, LinkedIn has over 100 million users and has about $250 million in revenue—so the company is for real. But profits are elusive. Will LinkedIn’s user base grow dramatically and will those customers turn into profits? I don’t think so. There are not enough professionals in the world who will want to network with each other to sustain the 100-percent-plus growth rates that would justify its over $8 billion valuation.

Almost all independent analysts who have reviewed Groupon’s IPO filings question the longevity of the company. They say the company has been spending more on acquiring customers than it makes in revenue, and it has prompted companies to offer such outrageous savings that they sometimes drive themselves out of business. It faces a slew of emerging competitors including Google and Facebook, as well as Living Social and hundreds of startups targeting specific niches. While the company bleeds money,  the profit margins on the deals it offers are under intense attack. Its  investors and employees have been cashing out of the stock at every opportunity in what seems to be a lack of confidence.  Yet, the word on the street is that this company will be priced at close to $20 billion in an IPO.

And $20 billion is the number being touted for Zynga. Its valuation on the secondary markets is already above $15 billion.  This game company pioneered a new method for making money by selling “virtual goods” in games, and its current revenues and profits are truly impressive. But is this sustainable, will this continue for another year, or three years, or five years?

I don’t think so.

And then there’s Facebook. It is already being valued at close to $100 billion. This valuation will probably double, maybe triple with the current hysteria. Is Facebook worth more than Google—which has been developing a wide range of technologies and pioneering new markets for over a decade? Don’t forget, Facebook has had virtually the same technology since it was founded, little has changed. Is this company worth as much as Apple—the most innovative company in the world? Again, I don’t think so.

I highlighted the potential for fraud that the secondary markets have created. But the damage those markets did was to relatively rich investors. Here the general public stands to lose their investments.

When this bubble bursts, it will freeze the opportunities for companies that are far more worthy, far more innovative, far more necessary for our economic growth than the ones that are currently reaping their fortunes. I fear it will set back the cause of innovation for another decade.

More on Innovations:

Wadhwa: Secondary markets and the next big fraud

Basulto: Don Draper, save our infrastructure!

By  |  08:42 AM ET, 07/01/2011

Categories:  Vivek's Take, Technology, Entrepreneurship, Business

 
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