I used to think Wall Street is very evil at sucking up the wealth of the rest of the country to line up the pockets of themselves while creating no real value. Nowadays I am pondering whether Silicon Valley is guilty of similar practices.
We see companies like Twitter, Salesforce, Netflix, etc goes IPO and commands a ridiculous valuation while having paltry profit/revenue under the name of "growth stocks", while suburban moms in mid-west buy those stocks up because they read about them on CNBC.
Then the founders/VCs cash out big time and then use the money to prop up the next series of startups, then rinse wash repeat. How much of this is sustainable? Maybe once in a blue moon a company with P/E of 500 is justified because they MAY be the next Google or Apple or Microsoft (ironically, none of those companies ever traded at that kind of P/E themselves, oh my..the days of only taking your company public AFTER you started making tons of money...), but these days when that kind of growth expectation is the norm then obviously most of them are in for a big crash in the future, since we aren't going to have a "next Google" every 6 months.
I wonder if this bubble will deflate slowly or crash and burn like it did back in early 2000s.
Sigh...I'm in my mid-20s and I actually work in SV but I already sound like a old geezer when talking to some of my peers about the tech industry's near term prospects.
If you think it's an absolutely sure thing that Twitter will lose money, there exist a variety of options to be compensated for providing your expert opinion to the market.
I did pretty well selling call spreads on Twitter. Sadly, I also had the same thesis for Yelp and Zynga.
I attempted to short TWTR today before the earnings, as a big gap down was absolutely predictable. I couldn't: my broker didn't have any shares. It's a security that is very difficult to borrow, due to extremely high short interest --in fact it has been the case pretty much since the IPO.
There might exist mechanisms, whether you can actually use them is another question.
I hesitate to mention this, since I don't want to recommend trading it, but for academic interest: you can create "synthetic" short positions using options.
The mechanics: Say hypothetically Twitter is trading at around $65. You post $1300 of collateral with your broker (cash or stock). You then sell 1 contract (100 shares worth) of Twitter calls with a $65 strike for the prevailing price (about $3.80 when I did it, or $380 for the contract) then use the proceeds of that to buy 1 contract worth of puts with the same $65 strike. When you factor in the spread, skew (slight difference in put/call pricing despite that they're "supposed" to be symmetric), and commissions, it likely costs about $100 to $200 total to enter this trade. Then you wait until earnings.
You would have, in the instant case, made out like a bandit. When the market opens tomorrow morning, your puts will likely be worth approximately $15, your short calls about -$1. You'd presumably choose to exit the trade rather than taking risk to ride it to expiration, so you'd sell the puts, buy calls to cover your short, and (after again paying the spread/commission) be up $1,300 for your trouble.
You can work out the math to prove this position is roughly -100 delta in Twitter: if the price of Twitter declines by $1, the position gains $100 in value, if it increases by $1, the position loses $100 in value. Neither side is capped. (Well, OK, the gain has a theoretical maximum if Twitter goes to zero before expiration but that's highly unlikely.) This is equivalent to shorting 100 shares.
Why isn't that totally free money? Well, if Twitter were currently $80, you'd be looking at paying +/- $1,500 to exit the trade. You also might find that happens at the worst possible time, due to a potential margin call on your short position. The market is a humility generation engine for people who think they're consistently smarter than it.
I never liked these fully levered positions. I prefer to just plunk down the $380 for the puts, maintaining the upside exposure, and cap the downside to $380.
When a stock becomes hard-to-borrow, the options will become more expensive. The theta will be equal to the accumulated interest charge until expiration.
Options can give you access to short-sales if your broker cannot locate shares to borrow. But in that case, what you need is not options, but a broker who participates in the securities loan market. Options will not provide a "free lunch" over simply borrowing the shares.
Of course, options do have the benefit of a truncated payoff. That's one thing you don't get with simple shorting.
Actually, he would have to believe that other people believe that Twitter will lose money, as stock prices go up/down based on expectations. That's how convoluted the stock market is :(
> Maybe once in a blue moon a company with P/E of 500 is justified because they MAY be the next Google or Apple or Microsoft
Well, in this case a P/E of 500 would already be a massive improvement. Twitter currently has a negative EPS (aka, no profits at all), so it doesn't even HAVE a P/E.
> I wonder if this bubble will deflate slowly or crash and burn like it did back in early 2000s.
Crash, probably, but not like in the early 2000s. The key difference now is that the internet is established and has multiple viable business models. Netflix has a P/E of 200, it wouldn't be surprising to see its stock price plummet from $400 to $40 (where it would then have a more sustainable ~20 P/E). But that won't change that the company is actually making money and has a profitable business model.
However that doesn't help the various startups and such that don't have viable business models, like Twitter which just keeps bleeding money with no sign of stopping.
Your comment actually demonstrates why P/E is at times kind of a dodgy metric. Do you know what will happen the minute any company (not just Twitter) which aspires to go from unprofitable to profitable changes from not having any earnings to having earnings? HUGE P/E. It's like that when you barely have any earnings, but that is not necessarily a an indication of profound overpricing.
Many of the VCs get in on the A-round, pump it up to the next VCs for the B-round, pump it up get it to IPO, and then they have their liquidity event where everyone cashes out.
The biggest thing that irks me is tech companies reporting non-GAAP numbers as their top-line results on earnings reports. These are baked-up numbers to make companies' large losses (or possibly small profits) look deceptively better than they actually are.
FWIW Twitter lists GAAP numbers above non-GAAP. They're also pretty up front about the fact that the discrepancy between GAAP and non-GAAP is stock-based compensation.
Agreed, Twitter at least reported them in the correct order.
Non-GAAP is still a sham in this case, because ignoring employee stock compensation to boost your earnings is like ignoring employee salaries to boost your earnings. It does not make sense for anything other than attempting to deceive investors.
Yeah I'm not really sure why that's such a popular thing, but I don't think investor deception is the point of it. I think I could argue that high stock-based compensation charges in the first few quarters after an IPO are an artifact of the way GAAP treats stock-based compensation in the first place.
But GAAP is handling it correctly. The dilution that stockholders will experience from stock-based compensation is very much real. And the earnings should reflect that.
Non-GAAP numbers are almost always done to deceive investors. In the dot-com days, it was EBITDA. These days, it's earnings before stock-based compensation.
A big chunk of the stock-based compensation they are expensing is related to pre IPO equity grants. E.g. if they granted some stock to an engineer in 2009, they now have to recognize that as an expense in 2013 because of the IPO. In my example, the dilution happened in 2009 but affects GAAP profitability in 2013. I understand why ongoing stock-based compensation should be included in the income statement, but I'm less clear about why stock grants that happened way in the past are important.
I posted this in another thread, but they acknowledged this situation in their S-1 (from last September).
Following the completion of this offering, the stock-based compensation expense related to Pre-2013 RSUs and other outstanding equity awards will have a significant negative impact on our ability to achieve profitability on a GAAP basis in 2013 and 2014.
> In my example, the dilution happened in 2009 but affects GAAP profitability in 2013.
Then Twitter should restate its non-GAAP results for 2009-2013 to subtract out the stock grants from previous quarters' results.
The numbers have to add up. If you exclude something from the non-GAAP results for one quarter, then it has to appear in the non-GAAP results for another quarter. The money cannot simply disappear into thin air.
If a company reports non-GAAP results, then it should be required to report a cumulative difference vs. GAAP. Over time, the cumulative difference should go to zero, as the timing differences are worked out.
It's not a Ponzi scheme. A Ponzi scheme requires some element of fraud, yet here you have Twitter's earnings statement and balance sheet right out in the open. There are reasonable people who think investing in a company presently running at a loss but with a potential for generating huge profits is a reasonable thing to do.
Just poking at your numbers a bit, of that 600M in R&D, 379M was from stock based compensation that hit them in the 4th quarter because of the IPO (they had to expense the RSUs at that point). Don't you think it's a little strange that $400M of the $600M in R&D costs were accrued in the 4th quarter?
I'm not advocating buying Twitter stock. Just trying to counter some of the overzealous cynicism in this thread.
Alright, let's try again (from the same balance sheet):
Year 2012: revenue 316M, cost & expenses: 394M
Year 2013: revenue 664M, cost & expenses: 1300M
year over year, revenue increases 2 folds, cost increases more than 3 times. Does that answer your question? You could also break it down by quarters, but the same trend is still there.
I hear ya. This is called the Greater Fool theory.
VCs know this. That's the reason they hype startups and ask young folks to "drop out and startup'. They are bound to make money somewhere (1 in 10 startups that IPOed big). Silicon valley is a big money sucking machine.
Btw, the Wall Street firms involved in underwriting the IPO already made a ton of money. The remaining guys fought over scraps and are making money now by strategic shorts and selling existing stocks to a greater fool.
It's quite pathetic really. "Changing the world" is quite possibly the last thing most startups are doing.
I thought twitter played a role in Arab Spring. They are a good company with a niche global impact. But they definitely did not command such a big IPO IMHO.
Of course I'm saying all this retrospectively. I don't have a time machine.
>sucking up the wealth of the rest of the country to line up the pockets of themselves while creating no real value.
Genuinely curious where you draw the line between "wall street" and the "rest of the country", especially with regards to creating "no real value".
I'm sure the vast majority of posters here have a car loan, student loan, or mortgage, which is just one example of where your pejorative use of "wall street" generates value.
As you say, "SV" (or the tech world in general) may be far more guilty of sucking wealth with no real value added.
Why not? Some people like taking risks in exchange for potentially much higher rewards. I have Vanguard funds as the basis of my retirement savings, but I've consistently done much better than the average while investing in individual stocks.
I find a great deal of parallelism between Greer's observations and Marc Andreesen's "Software is eating everything". The two great economic sectors of the past 20 years in the US have been the FIRE industries (finance, insurance, and real estate), and software / IT.
Broadly speaking, a society facing the end of an anabolic [growth] cycle faces a choice between two strategies. One strategy is to move toward a steady state in which C(p) = M(p), and d(R) = r(R) for every economically significant resource. Barring the presence of environmental limits, this requires social controls to keep capital stocks down to a level at which maintenance costs can be met from current production, and maintain intake of resources at or below replenishment rates. This can require difficult collective choices, but as long as resource availability remains stable, controls on capital growth stay in place, and the society escapes major exogenous crises, this strategy can be pursued indefinitely.
The alternative is to attempt to prolong the anabolic cycle through efforts to accelerate intake of resources through military conquest, new technology, or other means. Since increasing production increases W(p) and increasing capital stocks lead to increased W(c), however, such efforts drive further increases in M(p). A society that attempts to maintain an anabolic cycle indefinitely must therefore expand its use of resources at an ever-increasing rate to keep C(p) from dropping below M(p). Since this exacerbates problems with depletion, as discussed above, this strategy may prove counterproductive.
Yes, software provides efficiencies, and some of the recent chain of startups (Google, Twitter, Facebook) have succeeded in ephemeralizing knowledge, communications, and networking in ways which, to an extent, increase social interaction, but they're doing so at the cost of a highly confounded signal/noise ratio, and with significant externalities.
Then there's the whole "moving financial capital around" aspect of tech funding and investment, which I'm coming to increasingly question. I don't find it particularly productive. The number of firms whose exit strategy is "get bought by Google / Facebook / Apple" reminds me strongly of the late 1990s "get bought by VA Linux" (remember them?).
And for perspective, I'm in my mid 40s and have seen a few cycles so far.
Twitter, Facebook, and G+ offer a constant flood of content, but how much of it's really information? "Confounded" probably isn't quite the right word here, I'm mixing the ideas of "greatly worsened S/N" and "confounded" (as in mixed) "signal and noise". The point being that you've got to parse through a bunch of crud to find the meat.
Social networks are a pretty economically insignificant part of IT, though - Twitter/FB/G+ being worthless doesn't imply all that much about "software eating the world". (Yes, they're socially/culturally/... important; economically, they're outclassed by better business software.)
I'm not going to argue your point much, as I largely agree with it.
There is the question of use-value vs. exchange-value, and you could argue that social networks, as with other electronic communications systems (say, Craigslist) serve mostly to facilitate activities which wouldn't otherwise have occurred, and/or leave money in the pockets of those who make use of the services (where you'd previously have had to use newspaper classified ads, or staple flyers to telephone poles, or stand on a soapbox in the town square, or go out and meet your friends in person).
Most of the social networks have had fairly modest revenues. Let's see.... Facebook are claiming $2.5 billion for the three months ending 2013-12-31. That's actually not too bad. Google's $16.8 billion. Most of that's advertising, and if you think of it that way, Google, Facebook, and the other social networks are skimming off of the total advertising market (not insignificant).
Haha, although I do believe in Jeff Bezo and Amazon's vision, the current valuation is very high. I can see Amazon one day reaching Google's current profitability, but there is no way the P/E ratio would maintain close to what it is now (other wise Amazon would be worth about 10 TRILLION dollars). So the effect is that even if Amazon is tremendously successful in the future, the stock will probably experience a period of "relative stagnation" as the value of the company catches up to the tremendous valuation, then gradually grows proportionally with the profitability of the company.
Google is at about a $13b annual profit run rate these days. Amazon would need sales of $250b to $325b to hit that level. Needless to say, that's a very, very, very long ways off: maybe decades.
Companies can "grow" into the valuation by actually making more money (enough to justify the market cap), which is what many people believe will happen with Amazon
As for parent comment regarding WS / SV, I see WS as the TicketMaster of the business world: they end up taking the flak for all of the various practices, when in fact other entities (like VC firms) are also pushing for the IPOs and other questionable practices
It's entirely plausible Amazon will grow into its current valuation. What that really means however, is the stock will produce at best a zero return for the next decade. In the case of massive overvaluations, the future gains are merely pulled forward.
If we give Amazon a huge benefit, and say that ten years from now it deserves a 50% higher PE than Walmart currently enjoy (during a huge bull market); spot their future PE at say: 21. They need to generate nearly $8 billion in net income. Once again give them a huge benefit and say they can hit a 5% to 6% net income margin against their sales (Walmart tends to be in the low 3's). They need to get to $160b in sales in ten years, with excellent margins (for what they do). Possible? The sales definitely are, the margin will be hard to hit. That's the good scenario, and if they pull off that good scenario, the stock only breaks even in nominal terms; inflation adjusted it might be down by 1/3.
I think what we'll see in the future is the correcting of a few of these IPOs; none of these companies will go bankrupt though and bust completely. As mobile usage starts to thin out across all platforms(fb, goos, apple, etc.), overall growth will slow; we're seeing signs of that already.
Basically mobile usage will plateau and the market will correct itself in response. I'd say these companies will get a boost from international but it seems emerging markets are growing much more slowly than anticipated.
Silicon valley is just an extension of Wall Street. Where do you think VC's come from? The vast majority have investment banking backgrounds. I don't say that as a pejorative: I think Wall Street is quite valuable. However, it is prone to encouraging churn for the sake of it, and that carries over to Silicon Valley.
It's all part of the bubble that surely will pop eventually. It's not as heated as back in 2000 and the fundamentals are somewhat more sound, but it's still cooking and cooking and eventually it'll be too much. (see SV backslash, unaffordable rents and living expenses, etc).
"suburban moms in mid-west buy those stocks" There's no need to blame. Those investors are trying to make free money without doing productive work or even investing in productive companies. They're also the ones who lose the most if it fails so they automatically experience the rewards or blame financially.
Twitter has never made a compelling case for "regular people". The reality is that if you don't have a lot of followers the experience on Twitter isn't very compelling. You see lots of tweets from celebrities you follow but you don't see everything because the stream passes too quickly. You never tweet yourself because on the few occassions you did no one responded (you have 50 followers who either don't use the service often or when they do have the same stream overflow problem you have).
Twitter should seriously consider making people you interact with get precedent in the timeline. That would allow you to see tweets from people you know IRL easier and make interaction more common.
I wonder how much of this is a direct result of the destruction of Twitter's once vibrant app ecosystem. We have seen platforms that do this, time and time again, sputter and die. Platforms, such as iOS, who embrace developers thrive and grow to nice levels.
I can't help but agree. What made twitter so interesting and fun initially was how it was so easy to integrate with everything. It became a widely used messaging/information platform for apps to take advantage of while also allowing other devs to build their own spin on what a Twitter app should look and feel like.
I really think Twitter could have been better off by selling developer access to the pipes. Charge by the user or by the api call. Some way to still encourage the 3rd party platforms while also seeing some monetary benefit from it.
We see companies like Twitter, Salesforce, Netflix, etc goes IPO and commands a ridiculous valuation while having paltry profit/revenue under the name of "growth stocks", while suburban moms in mid-west buy those stocks up because they read about them on CNBC.
Then the founders/VCs cash out big time and then use the money to prop up the next series of startups, then rinse wash repeat. How much of this is sustainable? Maybe once in a blue moon a company with P/E of 500 is justified because they MAY be the next Google or Apple or Microsoft (ironically, none of those companies ever traded at that kind of P/E themselves, oh my..the days of only taking your company public AFTER you started making tons of money...), but these days when that kind of growth expectation is the norm then obviously most of them are in for a big crash in the future, since we aren't going to have a "next Google" every 6 months.
I wonder if this bubble will deflate slowly or crash and burn like it did back in early 2000s.
Sigh...I'm in my mid-20s and I actually work in SV but I already sound like a old geezer when talking to some of my peers about the tech industry's near term prospects.