Commentary: "Please God, Just One More Bubble"

Giddiness is creeping back into the tech sector. It's time for a reality check

Chastened by the tech bust, venture capitalists and entrepreneurs have spent the last couple of years taking startups back to basics. No longer could they expect to turn an idea scribbled on a napkin into an instant company and cash out in a couple of years. To get funding and go public, companies had to have solid technology and business models, experienced management, reasonable valuations -- and, above all, profits. This reassuring regime made it easy to laugh at a bumper sticker sighted around the Valley last year: "Please God, just one more bubble."

Now, it looks less like a joke than a warning. Too many tech investors, from Wall Street to Sand Hill Road, seem to be ignoring why they crashed after the 1990s hit a dead end. Venture capitalists are pouring money into look-alike startups in nascent sectors such as social networking. Even after a recent swoon, stocks of some dot-coms, such as eBay Inc. (EBAY ), look pricey. And not only are more money-losing companies going public, initial valuations can be distinctly frothy. Google Inc.'s imminent offering, for instance, could value the search engine phenom at $36 billion. Says Bill Burnham, managing partner of the VC firm Softbank Capital Partners: "Some people expect the good old days will be back and they can party like it's 1999."

Understandably, people in tech are eager to get in gear after idling for so long by the curb. There's also good reason for optimism: Tech spending is expected to rise at least 6% this year, the most since 2000. Plus, periodic spasms of excess can spark true successes, so getting just a little nuts ultimately may be healthy for the tech industry. Notes Reed Hastings, chief executive of the online DVD rental service Netflix Inc. (NFLX ): "It's out of this stage in the venture cycle that you get the Ciscos and the Microsofts."

Nonetheless, when even some cheerleaders of the last boom are worried that they're falling back into bad old habits, it's time to take heed. That's especially true at a time when momentum in some tech sectors could be slowing. Otherwise, we may see more nasty surprises like those that hit Internet companies in late July. Just a penny shy of analysts' estimates, for instance, Inc. saw its stock plunge 13% on July 23. "The enthusiasm has gotten ahead of the fundamentals," says Julie Farris, founder of e-mail startup Scalix Corp. So it's worth taking a closer look at the danger signals flashing in tech.

Let's start with the VCs. At least $50 billion committed to their funds has yet to be invested, even as more money is starting to pour into new funds. All that money is burning a hole in investors' pockets. That's why a few areas, such as nanotechnology, antispam software, and social networking sites, are starting to smoke -- worrying even some VCs. Says Vinod Khosla, general partner with the VC firm Kleiner Perkins Caufield & Byers in Menlo Park, Calif.: "Valuations are going higher, and some are starting to get irrational."

Nowhere is that more apparent than in the 200 or so social networking sites, such as Friendster, Tribe Networks, and LinkedIn, which help people find dates, friends, and jobs. You know something is askew when you see marginal sites such as HAMSTERster, for fans of the rodent, and, a swinger exchange. Such sites have logged little revenue, and it's unclear how they'll turn a profit, but that hasn't stopped VCs from investing $100 million or more in at least a dozen of them. "Social networking is probably the most overinvested venture-capital area," Kleiner general partner L. John Doerr said earlier this year. He should know: His firm has put more than $10 million into two companies, Visible Path Corp. and Friendster Inc. The latter was valued at more than $50 million at the last funding round late last year, though it had virtually no revenues.

And even with the tech-heavy NASDAQ exchange down 6% this year, the expectations of public investors may still be too high. At the recent Innovation Summit held by the online tech network AlwaysOn at Stanford University, two VCs and two investment bankers sat on a panel entitled "Is the Bubble Back?" Asked if they think the public markets are overvalued, all four raised their hands. "People don't understand the business models of the companies we're taking to market," conceded panelist Janice Roberts, a general partner with the VC firm Mayfield.

Smelling Blood

Indeed, the rise in shaky initial public offerings may be the most worrisome indicator that not all investors have learned their lesson. Some 44% of the companies going public so far this year were losing money, compared with only 30% last year, according to the investment bank Renaissance Capital. "They've lowered the bar," says Renaissance analyst Paul Bard. Why? "The VCs are pushing their companies to go out," says Jef Graham, CEO of networking startup Peribit Networks Inc., which has held off going public for now. "Bankers are like sharks smelling blood in the water."

Investors are starting to question the rush to go public. One high-profile IPO by nanotechnology leader Nanosys Inc. was withdrawn on Aug. 4 thanks to "adverse market conditions." Yet speculative issues remain on the docket. San Diego-based operating software firm Linspire Inc., for instance, announced in April plans for an IPO despite losing $1.6 million on just $1 million in first-quarter sales. Then there's Google. Despite its undeniable success and profitability, its valuation looks excessive. At $36 billion, it would be worth more than Ford Motor, Nike, or Caterpillar -- and almost as much as Yahoo! Inc., which has much greater experience and diversity. And the Risk Factors section in Google's prospectus runs a boggling 12,500 words.

Despite all those warning signs, it's hard to imagine people will get as wild and crazy as they did in the late 1990s. They had better not. With the devastation of the last bust still working its way out of the market, it's no time for folks in tech to blow it again.

By Robert D. Hof

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