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Friday, May 20, 2011

Energy and The Dot Com Redux

A quick follow up, to my post from yesterday,“Dollars of Future Passed”. In the prior missive I had noted that the bullish sentiment in energy bore watching. Yesterday, the chart did put in the beginning of a turn up in sentiment. The point at which the turn has occurred is somewhat higher than what I would have expected given the current state of things with the Dollar remaining firm. However, the energy markets which are sensitive to movements in the Dollar, as are the precious metals, may be sensing the beginning of the end for the Dollar’s current dead cat bounce. This chart bears watching as energy has been a market leader and if the sector does in fact turn it would be a net positive at least for what is being dubbed the risk trade.  I have marked prior turns as well as this potential turns with blue arrows on the chart below.



I actually find the concept of a risk trade amusing as I consider most of the investments in so called risk trades to be less risky over time than lets say plunking down my hard earned bucks for Linked in at 1000x earnings.
On a slight tangent I read an article regarding the valuation of Linked in and found it interesting. Back in “Dot Com Bubble” I recall how analysts and investors were using all kinds of metrics to justify prices of the companies they favored. These metrics were as crazy as eyeball counts and page hits which did not bring in any revenue. A poster child of this kind of valuation absurdity was the infamous Pets.com which is no longer part of the business landscape.

Getting back to the article, the author had noted that a companies like Amazon.com and Google also started with high valuations and look what they have become. The author further stated that he wanted to be part of the “social networking” investment area and that he believed companies right now are worried more about building the “platform” rather than profits. He also felt that these companies would prosper once the platforms were more mature. This is the same type of argument for many of the original dot com companies that are no longer with us today as well as the likes of Enron and its fiber optic build out. To steal a line from “Field of Dreams”, the “if you build it they will come” model is not a sound model, as  it can work sometimes but most often fails to live up to expectations.

To me this logic and justification for paying 1000x earnings harkens back to the Dot Com era. As the famous quote by Twain says, “history may not repeat but it sure does rhyme”. The IPOs and justifications of valuation for the Linked Ins and Groupons of the Dot Com 2.0 era business models do appear to rhyme. This is not to say that the companies in question cannot be profitable as I am sure that they can, but the question is one of valuation.

The difference between Google or Facebook versus Linked In is that of number of users is enormous and advertisers from which they derive most of their revenues are willing to pay up for that kind of exposure. Linked in has a nice upwardly mobile professional user base but it is much smaller in scale. While advertisers will be willing to pay for targeted ads I just don’t believe that Linked In can command significantly higher premiums for advertising, than say a Facebook. Facebook can both target specific demographics and offers access to a much wider variety of demographics at all levels of socioeconomic levels which Linked In cannot match.

As for one of the next rumored hot IPO’s to be coming I am sure will be Groupon and it will probably also get valued way to high as it seems that we are again pushing toward IPO euphoria which could be signaling a top.  Groupon is a wonderful concept and the deals they provide consumers can be quite spectacular, and I have and will continue to take advantage of them. The Achilles heel for Groupon is that the barriers to entry are quite low and there are other competitors already on the scene like “Living Social Deals” as well as others. At the moment Groupon is riding high because it has name recognition which is helpful, but if one of the rivals comes along with an innovation that Groupon did not come to market with first their thunder could easily be stolen.  

All I am saying is be careful out there because some parts of the market are beginning to feel a little like 1999 and I don’t know about you but I would prefer not to “party like it is 1999”. If you do party like it is 1999 just remember to make an exit before 2000 as we all know what happened then.

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