Is the bubble about to burst — again?
Investment in Internet companies has climbed so steeply since the dotcom crash of 2000 that some Silicon Valley veterans worry that too much money is again pouring into too many unproven, unprofitable ideas — setting the stage for another high-tech shakeout.
Watching venture capital firms invest billions of dollars in new companies last year, longtime Internet executive Richard Wolpert branded the upswing “a mini-bubble.” But “about a month ago,” he said, “I started dropping the word ‘mini.’ ”
In the first three months of this year, venture investors funded 761 deals worth about $5.6 billion. That’s up 12 percent from the same period last year and the highest first quarter since 2002. One sector in particular is heating up fast: media and entertainment.
The $254.9 million invested in blogging and online social networks in the first half of the year already exceeds such spending for all of 2005, according to Dow Jones VentureOne. The $156.3 million pumped into online video is also on pace to surpass last year’s investment.
The popular success of social-networking site MySpace, bought last year by Rupert Murdoch’s News Corp. for $580 million, and video-sharing site YouTube has inspired a spate of imitators. In online video alone, there are nearly 180 new companies — not to mention big players such as Yahoo! Inc., Google Inc. and CBS Corp. — vying to be the next YouTube.
But MySpace and YouTube have yet to make big bucks. And if neither of the industry leaders are profitable, some skeptical investors are wondering what hope there is for the scores of copycats.
“YouTube has been a cultural phenom,” said Mike Hirshland, a general partner with Polaris Venture Partners. “But how many YouTube knockoffs have been funded in the last six to nine months? The market has capacity for a certain number of successful winners. Whether it’s one, two, or, if it’s really exciting, three — you can debate. But eight?”
Venture capitalists say they’re being more responsible this time. Alan Patricof, who provided early funding for America Online, Office Depot Inc. and Apple Computer Inc., said the investment community probably won’t reach the late 1990s-level of irrational exuberance.
But, he added, “it certainly is the beginning of a heightened frenzy developing.”
The current run-up does differ from the implosion that began in 2000 and, within two years, wiped out $5 trillion in paper wealth on Nasdaq, the exchange on which many of these companies were traded. Nasdaq peaked at $6.7 trillion in March 2000 then plummeted to $1.6 trillion by October 2002. (It has since recovered to $3.6 trillion.)
For starters, venture investment remains dramatically below the first Internet boom’s height. The first quarter of 2006 saw less than 20 percent of the $28.1 billion spent in the first quarter of 2000, according to PricewaterhouseCoopers’ MoneyTree report, which tracks nationwide investment spending.
Also significant is the lack of investor appetite for initial public offerings. Unlike the last round of online exuberance, small investors aren’t buying shares in an online pet store with a sock puppet as its public face.
And the range of companies sprouting this time is narrower. In the 1990s, entrepreneurs tried adapting any number of business ideas to the Web. Now, they’re more sharply focused on free services that can be supported by the growing demand for online advertising.
Some investors argue that there won’t be another dot-com implosion, that the investment boom in online media companies is part of the natural ebb and flow of venture capital: Money plows in to unproven start-ups, winners emerge and the investors move on to the next opportunity.
“There are going to be a lot of flameouts and some spectacular winners, because even in bubbles some enormous companies that have lasting value were created,” said Gary Little, general partner in Morgenthaler Ventures.
Nevertheless, overinvestment carries potential consequences. If Silicon Valley again disappoints the pension funds and college endowments that bankroll venture capital, it could find itself spurned next time, stifling the next round of innovation.
“When there is a crash or implosion, it makes investors — both private investors and public investors — just reluctant to go into these categories, even if there are good investments there,” said Josh Lerner, a Harvard Business School professor and co-author of “The Venture Capital Cycle.”
The Nasdaq’s malaise is contributing to the interest in the latest start-up gold rush. Shares of Dell Inc., Intel Corp., Microsoft Corp., eBay Inc. and others are either stagnant or near multiyear lows. Fast-growing Google is the strong exception, but when its earnings growth slows — as its own chief executive has warned that it inevitably will — investors could flee.
With the public markets soft, money managers are desperately seeking other ways to get the returns needed to fund their pension plans, including hedge funds, buyouts and venture capital. The prospect of finding the next Google when it’s still young holds great appeal, and they’re willing to fund 10 venture-backed fledglings in hopes that one hits it big.
Putting bundles of cash into the hands of venture capitalists causes what the investment community refers to as “overhang” — too much cash chasing after too few brilliant ideas. That can disrupt the delicate courtship ritual between entrepreneurs and investors, producing too many bad pairings.
To veterans like Wolpert, it all seems familiar.
“If you screw up once, it’s an accident,” said Wolpert, former president of Disney Online who now serves as an adviser to RealNetworks Inc. and Accel Partners. “If you screw up twice, it’s a trend.”