Is There a New Tech Bubble?
The 19 percent drop in Twitter's share price on Thursday and 3D-printer maker 3D Systems' 33 percent decline since its Jan. 3 peak raise the age-old question of how much companies with high growth potential are really worth. Or, rather, how expectations should be valued -- and devalued.
On the face of it, there is nothing wrong with either company.
Twitter had its best financial quarter to date, showing 116 percent year-on-year revenue growth and positive earnings before stock-based compensation expenses, depreciation and taxes. It predicted revenue of at least $1.15 billion in 2014, 15 percent more than expected at the time of its initial public offering last November. The market, however, singled out two numbers: user-base growth of 30 percent, compared with 39 percent in the previous quarter, and a decline in "timeline views," Twitter's in-house measure that shows how many times pages were viewed, including reloads. Twitter explained that the decline occurred because structural improvements had made frequent reloading less necessary. To no avail: The market caught "slowing growth" signals and wondered how Twitter's $37.4 billion valuation, 32.5 times projected 2014 revenue, could be justified.
3D Systems is an even stranger case. It is a profitable company that anticipates revenue growth of as much as 35 percent this year, on the back of 20 percent growth in the last quarter. Professional 3D printing, in which 3D Systems is the market leader, is now a serious industry with applications ranging from aircraft engines to prostheses. The company did issue a profit warning, saying earnings per share in 2013 would be roughly 13 percent lower than previously expected. The explanation was perfectly reasonable: The company, which made 34 acquisitions since 2009, plans to buy more companies and step up research and development spending to capture more market share in an exploding industry. 3D Systems isn't a dividend stock, so if the market could sustain a $10 billion market cap and a price-to-sales ratio of more than 20 on the old profit forecast, why not on the new one?
"3D printing is real, but the stock valuations aren't," hedge fund manager Whitney Tilson wrote his investors on Wednesday. "The story is the same for pretty much every company in the sector, which is in a completely obvious and STUUUUUUUUUPID bubble."
Tilson, a value-investing proselytizer who has consistently shorted 3D Systems stock, explained in a previous letter why he believes the valuations are unrealistic. His theory is that a company priced at more than $10 billion and at least 10 times sales can only be a good investment if:
- it serves rapidly growing global markets;
- it has a winner-take-all (or at least most) business model;
- its business model is "light," or easily scalable with little capital required.
An ideal company that deserves a sky-high price-to-sales multiple, then, is a company that has a chance to corner a rapidly growing global market without spending much money. Like Microsoft in the late 1990s, Google right after its IPO or Amgen in the early 2000s. Ideally, it should be a company that either sells some ingenious Internet service or owns intellectual property that protects it from competition.
Tilson's criteria sound reasonable. If a company meets them, the market's ostensible overvaluation of its stock is a kind of advance, a materialized expectation of future dominance. It is pointless to calculate ratios using current financials when investors are in effect funding world conquest.
How many tech companies today meet Tilson's exacting standards? Twitter and 3D Systems, as well as all their competitors, certainly do not. No one company, not even Facebook, can corner the social-network market. And though 3D Systems founded the 3D-printing industry 30 years ago, it cannot dominate the market in the future: Many of the key patents in this field are expiring, so the oldest company in the market has to be aggressive both in acquiring potential rivals and in research and development. Besides, making increasingly complicated industrial equipment isn't exactly a "light" business model.
Using Tilson's filter, one could find hundreds of "bubbly" tech companies fit for short-selling.
There is, however, a problem with this strategy. People who adopt it will not necessarily win. Tilson's fund, Kase Capital, finished 2013 up 16.8 percent,underperforming the Standard & Poor's 500 Index by 15.6 percentage points. In the longer term, the incredible valuations of the likes of Twitter and 3D Systems may prove to be ephemeral. Both "social" and "3D" are buzzwords that may fade as "new new things" appear. In the short and medium term, however, there is money to be made. Investors in Twitter are still up almost 100 percent since the IPO, and those who bought 3D Systems a year ago have made a 44 percent return despite the stock's recent tumble. They would have done worse if they went with Tilson.
(Leonid Bershidsky writes on Russia, Europe and technology for Bloomberg View.Follow him on .)
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