Web 2.0 (Whatever that Means) - It’s NOT a Bubble

Since returning from the Web 2.0 Summit, I’ve heard and read a lot of different perspectives on its impact. From jaded VCs to hyper-successful entrepreneurs, I got a lot of the “ho hum” thing. Not that I understand this, as the stuff I saw and learned was intensely interesting and extremely cool, but given my newness to the field I guess this is to be expected. But the thing I am truly of sick of hearing are poorly argued views on why Web 2.0 represents a bubble. From my perspective, quite simply, it is not. And I’ll tell you why. For purposes of this discussion I will assume we all have a similar conception of Web 2.0, and it can best be defined as “You know it when you see it.” In short, all that Google/YouTube stuff and much, much more.

Some common reasons given for why we are in a bubble are provided below, with my counterpoints to follow:

Reason 1: A massively oversubscribed Web 2.0 Summit

IA interpretation: Where else can you network and lay the foundation for deals with the right people in one place? It is a matter of efficiency. Given the people I spoke to who were at the conference, most weren’t there to hear the presentations – they principally came to network and meet people that could help their businesses. This isn’t the sign of a bubble; this the sign of focused, successful people wanting to grow their businesses and make money. Not promotion, but execution. Chalk one up for me.

Reason 2: Google paying $1.65 billion for YouTube

IA interpretation: Yeah, this is a headline catcher. But who cares. Around 1.2% of Google’s market cap is going to YouTube.  Based upon the market’s reaction to the deal, it was effectively paid for overnight. There were plenty of strategic reasons for Google to do this deal.  Don’t be fixated on the number. Be fixated on the strategy and its cost to the firm. I’ve got to say I’m up 2-0 at this point.

Reason 3: Google acquiring JotSpot for a reported $50 million

IA interpretation: Again, people are confused.  Google buys neat tools and access to important communities. This is highly rational.  They are a cash machine. They are an execution machine. They are a research machine. They aren’t buying everything out there. They are buying stuff that either accelerates their progress in their chosen domains and/or takes something off the market that could substantially help a competitor. And this extends beyond acquisitions but also to strategic transactions, like the Fox Interactive Media/MySpace deal. This has absolutely nothing to do with a bubble. It has to do with a highly intelligent, aggressive company acting in highly intelligent, aggressive ways. 3-0, me. It’s a shutout so far.

Reason 4: There is so much VC money sloshing around that stupid Web 2.0 deals are getting done

IA interpretation: Invariably some stupid deals are getting done. But some stupid deals always get done. If anything, because it is easier than ever to start a company and angel financing has gotten more professional and is readily available, VCs are having an ever-harder time getting the deal flow they want. Lots of deal flow – but how much represents the slam-dunk stuff you can’t believe walked in the door and you get a term sheet signed ASAP? Also, as the range of potential business models and addressable markets has proliferated the breadth of possible investment opportunities has increased exponentially. This has prompted many VCs to spread their bets more than ever, as illustrated by the Charles River Ventures QuickStart program. This is smart adaptation to a rapidly changing and hyper-competitive environment. Definitely not a sign of a bubble to me. 4-0, me.

Reason 5: Too much VC money chasing too few deals

IA interpretation: While in many ways the venture capital businesses is in its halcyon days, it also looks like it has never been harder to generate the kinds of returns LPs are hoping for (and GPs are striving for). Many funds have gotten really big, and as a result the cumulative amount of value they need to create to achieve their targeted ROIs is stratospheric. Much has been written about this, so I won’t belabor the point. But the key issue here is that the phenomenon described in Reason 4 has made the VC business harder. Less capital needed plus more capital available equals a problem. But I don’t think the result is a bubble. I think the result is downsized funds and/or lower than expected ROIs. 5-0, brother.

Reason 6: Because “Yahootinis” were served at the Web 2.0 Summit

IA interpretation: Because some people write to sell newspapers, they say really stupid stuff. The feeling I got from Web 2.0 and some of the corporate-sponsored soirees is not “Woo hoo, let’s party like its 1999” but “Shit, I need to build better brand image and cement the perception of us as a hip, young company and not some Web 1.0 dinosaur.” If it takes a few designer martinis to get the point across, who cares? To me it smacks of quiet desperation, not a bubble. Yahoo!, for example, was working overtime through its presentations and its events to re-connect with the image builders and key influencers, because they know that if they are relegated to being last year’s platform they’ll get killed. This is valuable self-awareness and I thought they did a good job with their dog-and-pony show, but the reasons for this couldn’t be more anti-bubble. It’s survival – got it? You see, objective reality in this case is really the opposite of the MSM spin. Surprise, surprise. Man, I’m good.

Reason 7: Because people who don’t understand technology hear all this new stuff and think it’s crazy black magic

IA interpretation: It’s easy to throw stones when you aren’t accountable and have your own bully pulpit (read: a newspaper column). The presentations by Amazon, Google and Microsoft addressing infrastructure-related issues and opportunities were f*cking amazing. The issues are real, huge and have ramifications for the future of computing, storage and communications. Oh, but wait, there’s more. Changes in media, telecommunications, publishing, video and advertising are happening at such a rapid rate it is hard to keep track. And these changes are highly interdependent, with some stuff “expanding the pie” with others causing a redistribution of the pie. And it is too early to tell where things will end up, but one thing is for sure – it is wicked competitive out there, with companies and industries fighting for their lives. Rich Karlgaard wrote a nice piece in his latest Digital Rules column that looked at some of these very issues. And the fact that certain reporters (like Mr. Maney of USA Today) might find this boring does not in any way diminish its significance or in any way presage a bubble. Quite the contrary. Lucky number 7, 7-0.

Conclusion

There are lots of other bubble-ish issues that have been raised, but these were seven that were specifically bothering me. To me it is clear – WEB 2.0 - NOT A BUBBLE. VC discipline, rapid start-ups and failures, industries being re-shaped by the day, a virtually closed IPO market, the large players from Web 1.0 either re-inventing themselves or publicly moving into new domains (Yahoo!, Amazon, Microsoft) are all indicative of a healthy, innovative environment where the principles of creative destruction are on show every day. You are either moving forward or moving backward – there is no stasis (Virginia Postrel just did a great job outlining this concept in her most recent column in Forbes). This is good. This is what we want to see. Now if only reporters would check facts and use their brains, all would be well.

Addendum: David Pogue of the New York Times has a piece today titled Free AOL Stuff, Courtesy of Bubble 2.0. I generally understand and like David's stuff, and I enjoyed and learned from his critique of AOL's new features and functionality. What I don't understand is why AOL's drastic actions of lowering pricing to zero and abandoning the ISP business is somehow representive of Bubble 2.0. Again, it seems to me like aggressive acts of desperation in the face of inexorable decline. Creative destruction at work, with this sharply revised business model as AOL's response. Nice try - we'll see if it works. But the motivation is to clearly drive more (unpaid) eyeballs to their sites to generate more (paid) ad views which will, over time, compensate for the loss of subscription revenue. Is this indicative of a bubble? I think not.

Comments

[Kris Tuttle]

Having lived through the first bubble as an Internet infrastucture analyst one does get a tug every now and then saying "wait a minute, don't get too sucked in, look around and think this time!"

So far this lines up well my my fears (Geocities, Broadcast.com) and does a good job of addressing them.

However the one thing I would point out is simply public market valuation. During the Bubble of 1999/2000 we had software companies reaching 30x sales figures. In fact a major feature of "valuation" commentary was "if company BUB1 is trading at 26x and INKT is just 22x it's undervalued." Of course these are all *sales* multiples.

Looking at it today we refer to our monthly Web20 valuation sheet (it's free and available at www.research2zero.com/Web20Reports.html.)

The average for this diverse group is just 6.9x sales. Even the Google, the high water mark, at 19x sales trades in line with it's growth rate.

In short valuations still make sense in the public markets. True if we keep going at this rate without interruption we will get into some dangerous territory but we are not there now.

Neither have we had the kind of cathartic blast to the upside we did from December 1999 to March of 2000. Most sat open-mouthed as the market ran, shorts like Julian Robertson folked up shop, and Q1 tech earnings were up QoQ from Q4 in a dramatic break with the past.

The trends and technologies behind Web 2.0, virtualization and SaaS will certainly transform our business and entertainment landscape and that's just plain major business.

We have an old report from April 2005 (also free) that goes into that in some detail.

[howard lindzon]

A great post indeed.

[Jason Wood]

Roger,

Spirited post, but having survived the last bubble (as you did), I think you doth protest too much in your new role of startup executive.

There IS most certainly a bubble building, but that's OK. As Paul Kedrosky is fond of saying, venture capital is a bubble business.

By nature of the business, if a lot of bad money isn't flowing into me-too deals, it's probably not a space with legs.

In the Web 2.0 case, what we're now seeing is frankly a lot of bad money being put to work alongside some absolutely astute and highly profitable investments. That's perfectly normal.

But what we all need to be mindful of is the bubble spreading back into the public equity markets where it can do a lot more damage.

While we've been disciplined SO FAR, deals like Salary.com and eFutures are real cause for potential concern that we've forgotten the lessons of the past.

Bset,

J

[Yaser Anwar]

RE- If I may, I'd like to include excerpts of my interview with Andy Kessler (Former MS Tech Analyst, HMF & NYT Bestselling author). I asked him some of the questions pertaining to the points you brought up.
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Y: Would you consider the amount Google paid for YouTube, $1.65 billion and circulating rumors that Yahoo's in-talks with Facebook for a $2 billion buy-out, make you reminiscent of the tech bubble in 2000?"

AK: Google buying YouTube is quite reminiscent of Yahoo buying GeoCities, an acquisition in search of a strategy. But I’m not sure it is reminiscent of an entire tech bubble. It is fairly isolated. There are few IPOs. Equities are not disgustingly overvalued. Sure VCs are overfunding so-called Web 2.0 companies, but there have not been many liquidity events. It is still shoot and wish vs. shoot and score.

We’re not at a bubble, not yet anyway. The market is paying up for growth. When it pays up for “should” or “oughta” or “might someday” kind of growth, then I’d be a lot more nervous.

Y: Do you think we are at an extreme point in the venture capital industry, six years after the tech bubble burst? Considering that since September 1st there have been 7 U.S. technology IPOs, only one of which, Shutterfly, is currently trading below its issue price.

Note: This question pertained to market climate 1.5-2 weeks back.

AK: Not really.

Y: The average performance since inception of these seven IPOs is 47%, more than four times that of the 14 non-tech IPOs during the same period. Do you think this trend is sustainable?

Note: This question pertained to market climate 1.5-2 weeks back.

AK: I think the IPO window is starting to open up as more companies reach the stage of maturity that used to be considered quaint, eight quarters of growth and at least two quarters of profitability. Seven is too small a sample. You’ll see some interesting companies go public over the next six months. The problem with venture capital is not the IPO market, but is too much capital and too few new ideas.
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