Valuations: Is this nuts? Investors appear to have taken leave of their senses, pumping cash into projects regardless of profitability

January 17, 2014 7:55 pm

Valuations: Is this nuts?

By Paul Murphy

Investors appear to have taken leave of their senses, pumping cash into projects regardless of profitability

This week Google agreed to pay $3.2bn for a privately owned four-year-old start-up. Nest specialises in smart gadgets for the home, such as a WiFi-enabled thermostat that might cut heating and cooling bills.Whether Nest, founded by former Apple executive Tony Fadell, is worth $3.2bn, no one can say. The consensus among the technorati and in financial circles is that Google paid so much simply because it could, and it does not really matter anyway since it is acquiring the services of Mr Fadell, who helped develop the iPod.

Is this a sane approach to business investment? While macro strategists tell us that US companies in particular are over-investing in the face of sharp deflationary pressures and shrinking margins, is it really too cloddish to ask again whether, in a world awash with easy money, a combination of tech-fever and feverish greed has caused investors to lose touch with reality?

Fifteen years have passed since the Great Dot Comedy. The era has been mocked ever since, yet many specific instances of craziness have been forgotten or brushed away.

In the same way that a company can invest $3.2bn in a man producing thermostats and smoke alarms, there were similar examples of investors betting fortunes on individuals before those people even had a business to invest in. In short, investors were prepared to pay a premium for cash.

All that was needed was for three or four well-known business figures to band together and express their interest in acquiring something in the field of the internet. They could then list the resultant shell company, raise cash and watch as the value of their sole asset – money – set off in the general direction of the moon.

Investors suffered a collective psychotic episode. The fact that successful businesses depend on sane business models, which bring in customers and profits, had been scrubbed, temporarily, from their minds.

Yet, 15 years later, it is considered dull, stupid or both to question the $40bn valuation afforded Twitter. As the tech analysis team at London brokerage Aviate told clients at the time of the initial public offering: “The opportunity for Twitter is to become the largest real-time delivery system, large enough and pervasive enough to exert noticeable ‘pressure’ on the overall internet itself.” Twitter, we were told, is “all about now”.

Since the messaging service joined the New York Stock Exchange in November, Silicon Valley has continued in its role as a seemingly magical valuation creation machine. This week Square, the mobile payments business, was valued at $5bn after a private placement that allowed a number of insiders to cash out $135m of stock. There is no discussion of profitability anywhere near this. Revenues might get a mention but only as a secondary matter to market share.

These bubbly valuations are not restricted to west coast tech. With stock market indices also pushing to record highs in Europe, there have been a string of examples of listed company valuations parting ways with traditional valuation yardsticks. Asos, the London-listed fashion portal, is trading at almost 100 times forecast earnings. Ocado, an online grocer that has yet to turn a clean profit in 13 years, has been re-rated as a tech company, quickly doubling its value to more than £3bn. Moncler, an upmarket Italian ski jacket maker, surged 44 per cent when it listed recently in Milan.

Similar dynamics are visible in other asset classes. Irish sovereign debt yields little more than UK Gilts, despite the trauma of Ireland’s banking sector collapse; the yield on Portugal’s 10-year government paper has fallen 30 per cent in four months.

All of these valuation movements, from Palo Alto to Lisbon, can be explained away individually. Maybe rich Russians will flock to Moncler’s Alpine shops this season; Asos might achieve its global ambitions; and the thermostats of the future may be smart and beautifully designed.

But it is clear they share a common fuel: quantitative easing. Cheap money has given us a period of “wild abandon”, says Andrew Lapthorne of Société Générale. Roll on QE4.