FT Wealth Forum: Web 2.0 or Bubble 2.0?

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Internet stocks are back. Seven years after the bubble burst in 2000, Google is among the hottest stocks in the US, while a new breed of web companies featuring user-controlled content, such as MySpace, YouTube and Flickr, have shot to prominence and then sold out to established players. The internet is now being used for selling and distributing music and videos.

But multiples for “Web 2.0” companies have provoked scepticism that valuations are once again getting overheated. Is it really different this time, or is the market making the same mistake?

James Altucher of Formula Capital; Cody Willard of CL Willard Capital Management; Porter Bibb of Mediatech Capital; Ryan Jacob of Jacob Internet Fund; and Henry Blodget, author and former stock analyst - all with hands-on experience of the first internet bubble - argue it out.


Eddie McCaffrey, London: The advent of ‘Web 2.0’ is beginning to have a significant impact in the world of corporate communications. Take, for example, BMW’s use of short feature films on bmwfilms.com. What impact do you think the business world’s adaption of Web 2.0 - particularly in the video production field - will have on more traditional media and advertising?

Ryan Jacob: One of the most disruptive elements that the internet is having on the traditional media business today is how it is changing the way companies look to market to potential customers. BMW was very early embracing the internet as a marketing channel, but most companies today look at it as a key part of their advertising programs. The advent of Web 2.0, specifically targeted video content, will likely have the deepest impact in the advertising field over the next few years.

Models and methods are being tested every day, but I believe we will see standards take hold soon (probably led by innovation from Google, which we own) and be adopted relatively quickly. The advantages that Internet advertising enjoys in display advertising (targetability, trackability and wide reach) should translate well to various forms of video content.

James Altucher: Web 2.0 is this idea that now the users (as opposed to large content companies and commercial interests) are responsible for creating the never ending dialogue and content that exists on the Internet. This is not very different at all from “Web 0.9” circa 1994 -97 when the web was primarily made up of individual home pages rather than corporate homepages. Then, as now, companies were quite rightly concerned about advertising side by side with this content. Advertisers have two choices: to broadcast to this new universe of user-generated content with banner ads, rich media ads, etc, or to participate in the ongoing dialogue.

Both will happen. “Traditional” online advertising will continue to steal market share away from media like print, radio, television, and will gradually go from 7 per cent of advertising dollars to eventually close to 50 per cent. But also, advertisers will begin to engage in the dialog by attempting to create their own viral videos, community sites, and other brand-building activities. Currently this has led to the development, within ad agencies, of “Viral video” departments and blogging departments to teach their corporate customers the basic tools of this web 2.0 world.

However, just like in the Web 0.9 days, the sincere voices will rise to the top, corporate or otherwise.

By way of introduction, I ran a Web 1.0 development company in the 90s, developing sites for HBO, Sony, Disney, Miramax, American Express, and dozens of others. More recently, in addition to running a fund of hedge funds, I’ve also developed and help run a very popular Web 2.0 site in the financial space, Stockpickr.com. The same concerns advertisers had 10 years ago, they have now. But they are constantly developing creative ways of dealing with these concerns.

Porter Bibb: BMW’s films on the web were made by high profile professional feature film directors. They created a terrific stir, more because of the participation of these famous filmmakers than the content of their short films. The result of this extremely expensive effort was a lot of publicity for the BMW brand, but probably very, very little impact on consumer choice and virtually none (according to BMW) in the sales column. Web 2.0 will impact Internet video in a far different way - extremely low production costs; less attempts at narrative and more efforts to show products in actual use by real people, albeit celebrities or recognizable personalities, caught by cellfone cameras; and much more interactivity between viewer/consumer and filmmaker/advertiser (eg Viewer creates end for film; Viewers vote on films’ viewers, file favorite films on YouTube type peer/share archives.

Henry Blodget: The history of the media industry suggests that the Internet will continue to reduce the power and influence of traditional media businesses, but not destroy them. (The introduction of television changed and reduced the influence of radio; cable TV reduced the influence of the broadcast networks, etc.) In a world with a nearly infinite supply of content, the power will continue to shift toward companies that can facilitate fast, convenient, user-driven access to all forms of it — such as Google and Yahoo. This will reduce the influence of monolithic, single-medium “programmers,” such as television networks and newspapers. This said, the value of unique, engaging content will not disappear: Great TV shows will still attract millions of viewers, great books - millions of readers, and great clips/blurbs/posts millions of online users.

As for advertising, as the success of paid search has already demonstrated, successful online advertising will be very different than successful advertising in traditional media. Internet users, for example, won’t tolerate 30-second video ads. With online video, I suspect that you will see more embedded sponsorships — logos on the corner of the screen, product placements within videos, etc. — as well as other forms of advertising that haven’t been thought of yet.

[I own Yahoo directly and Google through an index fund]

Cody Willard: Certainly the big agencies will finally start figuring out how to leverage the internet for every new marketing campaign. And we all are well on our way to eventually consuming almost all of our video from the Internet rather than having 100,000 hours a month of programming, of which we watch .01 per cent, into our cable boxes. More to the point though, it’s the forums such as YouTube and the ability for anybody on the planet to produce and then widely distribute their own video products, including campaigns, that will really start to have an impact. Imagine if BMW were smart enough to hold a contest on YouTube or BoomRevolution.com (full disclosure — I’m a founder of that site, more on that later today, as I’m sure it’ll come up again) or any other user-generated video site for the best BMW commercial. Now that would be exciting! Matter of time before it all starts to happen too.


Emmett Kilduff, London: What listed European internet stocks are there and what 2007PE multiples do they trade at?

Ryan Jacob: Well, there are quite a few, and honestly we have not found many European internet stocks that are attractive recently. Generally, valuations tend to be higher than their U.S. counterparts. Also, because of the smaller markets they generally address, it makes us a less enthusiastic to pay higher prices.

However, we do have significant positions in Chinese internet companies and think they will likely perform well in 2007 for a number of different reasons. I’d be happy to elaborate more on that if there is an interest.

Cody Willard: I suppose you can consider Telecom Italia, BT, and a few other telecoms as Internet plays in Europe. There’s also that incredibly ill-conceived Chirac-baked, er Chirac-backed Quaero.com. It’s rather mindblowing to me that the French government thinks that they can create a product through bureaucracy and all the endlessly political infighting that comes with all governmental-agencies that has any chance whatsoever to take on companies like Google (which happens to be the single fastest growing company in the history of capitalism — or socialism for that matter!) and Microsoft. The end-game of the Internet, as I write in this weekend’s FT US edition paper, is the total empowerment of the end user. Somehow I don’t think the French government gets that.

Porter Bibb: Our firm does not deal in European shares, but we watch the markets there fairly closely for investment opportunities/consolidatiion targets. European-listed Internet related stocks, however, are too numerous to mention here. Our (somewhat conservative) best bets, however, are BT (British Telecommunications plc) which is expanding globally (and acquired a valuable IT services company in the US on Wednesday). BT has a very attractive PE of only about 16X. Another interesting Internet play is Carphone Warehouse (which recently acquired AOL’s UK operations). Carphone is listed on the London Stock Exchange and has a PE of nearly 40X, probably a bit pricey for most, but considering the company’s strong position as a retailer of mobile and wireless services, probably still a decent investment for the long haul.


Nicholas Lovell, London: If we are seeing a rerun of the 2000 bubble, when will it burst and what will be the catalyst?

Ryan Jacob: Well, in my opinion, we are not anywhere close to the bubble situation we had in 1999-2000. The obvious difference is that many companies back then were barely profitable (if at all) and the amount of capital available for new businesses was something we are likely to never see again in our lifetimes. Also, back then companies’ secondary offerings of share were plentiful as companies loked to cash in. Today, companies in our space are buying back stock aggressively and more attuned to the bottom line. Far from irrational behavior. We have seen some money flow back into technology/internet, but it has been eclipsed by the tremendous demand for commodities, real estate and energy. How far that trend continues remains to be seen...

As far as a catalyst for a bubble burst, I think as long as we are arguing about whether Google is expensive at 35x forward earnings in our sector, we have a ways to go.

Cody Willard: I don’t think we’re even close to seeing a re-run of the 2000 bubble yet. But I do think the odds of entering another 2000-like bubble over 2007-08 are high. As it is right now, Google is trading at about 30 times 2008’s estimates. Of course, when Google went public below $100 a share in 2004, the analysts who called it an indication of another bubble back then because it was trading at 40x 2004’s estimates missed the fact that Google would end up earning much, much more than what the estimates had guessed they would. It turned out that Google went public at only 12x what it actually made in 2004. The same is true for Google’s valuation today, as it earned over a billion dollars in just one quarter and will do that again each of the quarters in 2007. It’s not being valued in eyeballs, but on real earnings.

Google has figured out how to monetize any real traffic flow on the Internet. It can profitably guarantee MySpace.com hundreds of millions of dollars because it can monetize that traffic. And it paid almost $2 billion for YouTube for the same reason. I call this the Google put and what it means is that any site that actually generates real traffic is either going to be bought by Google (or by one of the Google wannabes) or they will partner with Google.

And we’re still very early in this cycle. As Vista takes us out of the text-centric networked world and into the video-centric networked world, we will all be consuming ever more of our content on the Internet. As James noted above, ad dollars to the internet still only account for 7 per cent of the total spend on advertising. That’s going much higher. I expect that the Vista and Internet video boom will fuel the fundamentals on the Internet and companies supplying the Internet to much better than currently expected levels for 2007 and 2008. And as markets usually do as Soros’ theories of Reflexivity would tell us, we’re very likely end up shooting too far on the upside and then things really might get bubblicious.

For the record, that would be disastrous for 2009 or 2010 when such a bubble would probably start to pop.

James Altucher: Under no circumstances are we even close to a re-run of the 2000 bubble. The bubble of 1999 and 2000 was more of an IPO bubble than anything else. Many companies (over 200) were going public that had no revenues, no earnings, and were losing tens of millions of dollars a year. This created an abundance of supply (many new shares of newly public companies) and once demand started to crack due to the Fed tightening and impending recession, the stock market, like any market ruled by supply and demand, cracked.

Right now we have the EXACT opposite situation. No Web 2.0 companies have gone public. In fact, because of share buybacks and lack of new IPOs the actual supply of shares on the US stock market has gone down for 2 years in row in 2005 and 2006. Furthermore, there are many dotcom companies that are produicing hundreds of millions in revenues and tens of millions of cash flows that are choosing, for now, not to go public for various reasons. Zappos.com and Art.com being prominent examples but there are perhaps two dozen other examples.

Don’t be worried about another bubble. Instead, now is the time to begin placing bets as we are extremely early in this game.

Henry Blodget: Mmm…the $64 billion question. I don’t think it is likely that you will see an exact re-run of the 2000 break, if only because there are about one-tenth as many public Internet companies today. Also, the leading companies are much more mature — and much more reasonably valued — so it seems unlikely that, say, Google will drop 97 per cent, the way Yahoo did in 2000-2001. Lastly, the stock of almost every major Internet company except Google is already well off its high (eBay, Yahoo, and Amazon are down 40ish per cent, AOL has disappeared). I think it is likely that there will be a day of reckoning for Google, but I doubt it’s headed to zero.

All that said, there will ABSOLUTELY be a day when the current Web 2.0 music of “We don’t need a business model, because we’re going to sell to Google” will stop, leaving about a thousand start-ups suddenly wondering what happened. What will precipitate that? Probably either a global recession, which will whack advertising spending, or a click-fraud scare, which will cause advertisers to stop advertising on third-party affiliate networks. Or just because, at some point, the music always stops: The number of companies attacking the opportunity will vastly exceed the size of the opportunity, and suddenly everyone will collectively remember that businesses need to sell stuff.

Henry Blodget: Well, we all seem to be in comfortable agreement that there won’t be another crash… So look out below.

Porter Bibb: The so-called Web 2.0 (not readily defined as yet) is already approaching bubble stage. Check out the incredible rise in not just Google, but Google-like search firms like Baidu. Most observers agree that there is continued growth in most Internet-related shares, but much of that speculation is based on continuing increases in profits which today are mainly advertiser-driven. Any slowdown in the economy or in advertising expenditures will depress online profits and bring many, if not all of these stocks back down to earth. A good barometer might be AOL (still part of Time-Warner, but who knows for how long?). Having given up over $1 billion from subscriber fees when AOL went free last August, it remains to be seen whether those profits can ever be replaced by new advertising, despite the fact that AOL remains one of the most visited sites on the Internet.

Cody Willard: Porter, the incredible rise in Google, which I have owned since the day it became public, has nothing to do whatsoever with “bubbling”. It is because the company generated so much more profits than mainstream analysts, who were very much in a negativity bubble, thought they would.

And I have to say also, that AOL is a terrible company, that has burned all of its customers for years with its lock in strategies such as not letting users take their or forward their AOL emails away from their platform. Lock in is dead. Control is dead. AOL never got that and there is no reason to expect those thousands of MBAers and attorneys and the rest of their corporate groupthink who run that place will finally get a clue. AOL will never die, by virtue of its sheer size and brand recognition. But it’ll never matter to the future of the Net either.

James Altucher: Part of the problem I have with this whole discussion is the word “bubble”. A bubble occurs in financial markets when the only reason an asset goes up today is simply because it went up yesterday. Dotcom stocks in 1999 were going public at $30/share and then going up 10-20 bucks a day without any regard to fundamentals. People were only playing the price action.

Today, we can argue all day whether or not AOL is a good company (I think Time Warner is an excellent company run by a top 5 management team starting with Jeff Bewkes and Dick Parsons and reaching throughout the company) or whether or not Google deserves a multiple of 40 times earnings. Ttat is fine, its a debate, and debate over valuation is what makes a market. It is when the market falls apart, the debate becomes meaningless, and prices become stratospheric that things become a bubble.

As for Web 2.0 “bubbling” because of lack of business models, this couldn’t be further from the truth. Online advertising is going to go from $18bb in 2006 to $24bb in 2007. This is still a drop in the bucket compared to overall advertising in the US. Meanwhile, on the commerce side, you have companies like Zappos.com which is already up to $600m in sales a few short years after it has launched.

The world is a lot different now. I was able to build and launch Stockpickr.com this year with a much different group of resources than was required in 1998 and, as you can see from our site, we already have well known advertisers, and a building community. This is web 2.0 and its just not the same as the “poof” companies in 1999 that were created only to IPO and have lipstick put all over them so that shareholders would buy without meaningful debate of value.

Ryan Jacob: Its actually funny that with our portfolio (which is a publicly traded mutual fund) we try to balance the weightings between growth and value situations. I know that some people look at “internet value” as an oxymoron, but the fact is we find plenty of stocks in our sector where companies are trading at very low price/sales and high cash levels relative to their market cap. Investors in our sector tend to be fickle and not very patient which opens up opportunities quite frequently. This gives us upside potential with markedly less risk. These situations were few and far between pre-2001.

Porter Bibb: I agree with Cody regarding AOL’s likely relevance (or irrelevance) to the future of the Internet. My using AOL as an example, however, seems entirely pertinent, at least in the context of his assessment of Google and its continued development prospects. If Google’s “put” is to acquire or partner with any significant generator of eyeballs, which Google can then monetize through increased advertising revenues, why hasn’t Google scooped up AOL, which still draws more traffic per month than all but three or four of the largest sites? Okay, Google did buy 5 per cen of AOL last year, but that was merely to keep Microsoft from picking up all of AOL.

I also agree with Cody that we are pretty early in the cycle and with Henry that any burst of the bubble is unlikely to bring Internet stocks (of which, as he points out, there are far fewer than in 2000) all the way down to zero. But it may be unrealistic to compare advertising on the net (whether video or otherwise) to advertising in Old Media. It will be a long, long time before advertisers will equate the value they can receive from a $2.6 million investment in a 30-second spot on CBS’ SuperBowl broadcast with a similar investment anywhere on the ‘Net.


Ian Williams, New York: Those multiples may look sounder than last time if they are based on projected growth. But with the rapidly evolving pace of the technology isn’t it possible that the likes of Google will be suddenly made obsolescent by an upstart company with a better internet mousetrap. Is that worth factoring into these rosy valuations?

Henry Blodget: Yes, it’s possible. And a sharp deceleration in growth would result in the same multiple compression.

Unfortunately, one just can’t invest in a sector like this without taking significant risk.

Porter Bibb: There will always be someone coming along with a Better Internet Mousetrap. But Google, Microsoft and Yahoo have such substantial franchises and such headstarts on any newcomers that the Newbies are much more likely to be acquired than to become a serious threat to these Internet monoliths. Nothing lasts forever and the technology underlying the existing market leaders can and probably will be improved upon by others, but as Cody and others have pointed out earlier today, the Internet still accounts for only about seven percent of total advertising expenditures in all media - suggesting that their logical and expected revenue growth in online media will not easily or quickly decimate today’s market leaders, but create more profitable ways for advertisers to invest their money, exactly the way Old Media proliferated and expanded over the past five decades.

Ryan Jacob: Actually, I think this is a great point. This is probably the single issue that keeps me up at night more than any other with Google being a top position in our fund. While Google has many different new products and services that they plan to introduce in the next few years, so far their search business is basically all of their revenue today. That being said, keep in mind that with over $15 billion in revenue expected in 2007 and over $10 billion in cash on their balance sheet, they are in a very enviable financial position. It will be hard for a small upstart to challenge them.

Cody Willard: When analyzing Internet companies, one needs to be sure to factor in such dynamics as Metcalfe’s Network Effects and the virtuous cycles of community building that comes when a network hits critical mass. Metcalfe’s Law states:

“The power of the network increases exponentially by the number of computers connected to it. Therefore, every computer added to the network both uses it as a resource while adding resources in a spiral of increasing value and choice.”

And while communities like MySpace and YouTube can and will lose their coolness over time, when networks like that hit critical mass and become de facto standards the virtuous feedback loops of ever more users making ever more developers use those networks which makes ever more users come to those networks...well, that’s why it’s called as virtuous cycle, I suppose.

Regarding Google, that’s another argument I’ve been hearing for years now. If it were easy to render Google obsolete, Softee and it’s billions certainly would have done it already. Somebody will come and really compete against the Google. But we’ll have some time to get out even if its not at the top if that does happen. I think the upside potential over-rides that remote risk. (There are plenty of less remote risks such as an outright Google backlash as they control so much data about all our Internet usage...but that’s another can of worms )

Also, I’d just note that you can make the same argument about the risk of obsolescence in any industry at any time. Nobody would ever invest in anything if they were always waiting for the better mousetrap.

James Altucher: The thing is, there already are better search engines than Google. Maybe not from a storage point of view (Google has more data stored on their servers than anyone else) but from an algorithm point of view (IACI’s Teoma, for instance). And even Google plays around a bit with their searchmash.com experiment.

But Google is really an advertising company. And on this level there will be competition in the form of Yahoo’s Panama, and perhaps other products/companies. Which is why Google is trying hard for some other success (YouTube, Gmail, etc).

I think YHOO will close the gap between the two even though Google has an enormous head start. Yahoo has the most users across its many sites of any other company. Those users can also be sliced demographically just as easily as the users of Google’s ad network if not even more easily. So there will be competition. But that is real competition in a real market where there is actual value (advertising now being dominated by cost-per-click rather than the blind CPMs that dominated the late 90s) being created and tracked.

So will there be competition? Absolutely. And I think there will be opportunities to invest in that competition and participate in the value being built.

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