Silicon Valley’s hype bubble is ready to burst

Billion-dollar startups are driving talk of another dot-com crash. But while the hype will implode in 2014, there’s still real money to be made

apps falling off a smartphone screen

In June 2007 the founders of what was then known as Twttr entertained a buyout offer from Yahoo. At the time Twitter had 250,000 active users and an impressive rate of monthly growth. But it also had no strategy for making money and no imminent plan to produce one. So the offer Yahoo tabled, and Twitter rejected, according to an account in Hatching Twitter, a recent book by Nick Bilton, was an understandably muted US$12 million.

Flash forward to late 2013 and Snapchat is in a similar place to where Twitter was six years ago. The company makes no money. But its app, which allows users to send pictures to one another that quickly disappear, had a strong and growing user base. And just like Twitter before it, Snapchat had web giants sniffing around, asking about a buyout.

But if the bid Twitter received was modest—some might call it low-ball—the one thrown at Snapchat was anything but. According to the Wall Street Journal, Facebook offered Snapchat US$3 billion for a takeover in late November. That’s US$3 billion for a company that has no revenue, let alone profit. Remarkably, Snapchat turned it down.

The difference between the offer for Twitter in 2007 and the one for Snapchat in 2013 was the difference between a market still smarting from the bursting of the last tech bubble and one some worry could be inflating the next one. By late last year, people—investors, angels, venture capital firms—were all overpaying for growth in technology startups and stocks, just as they had been 14 years earlier at the height of the last bubble.

According to Janus Capital, investors are getting caught in a “hype cycle” around cloud computing and social media. And almost no company has more hype than Twitter. Valued at just US$12 million six years ago, Twitter had a market cap of over US$40 billion at one point in December. That despite never having turned a profit and earning just US$600 million in estimated revenue in 2013. But Twitter—which went public in November—isn’t the only over-hyped tech stock. In November, the Nasdaq composite index broke 4,000 for the first time since the last bubble burst, inflated by stocks even some CEOs, such as Elon Musk from Tesla and Netflix’s Reed Hastings, warned were overpriced.

Twitter share price since IPO

When CEOs of successful tech companies are downplaying their stocks in public, you know the market is overheated. But that doesn’t mean we’re headed for another huge tech crash. For all the hype, 2014 is not 2000. Companies are not rushing to IPOs in the same numbers or at the same speed as they did in the original dot-com crash; and retail investors are less exposed than they were in 1999, when every widow and orphan was betting the farm on Netscape and Twitter, for instance, took advantage of new U.S. regulations to tout shares to large institutional investors first. And while Snapchat’s headline-friendly $3-billion valuation seems insane, it’s still a private price. In the first tech boom, the Snapchats of the world were going public at the first opportunity. Now they’re staying private much longer, keeping the lion’s share of the risk out of the public markets.

What will collapse in 2014, however, is some of the hype around Silicon Valley in general. “Tech is vulnerable,” says Colin Cieszynski, a senior market analyst at CMC Markets Canada. But not to the kind of 80% plunge the industry saw in 2001. Instead, Cieszynski believes, the industry might see a much smaller correction this year, something in the 5% to 10% range. In his view, the market is in the middle of a cycle. A correction now will keep it from overinflating, preventing exactly the kind of mania that led to the dot-com explosion.

Investors have already taken the pedal off the gas when it comes to Twitter. After breaking US$74 a share in late December, the stock retreated below $65 in the new year. Analysts are still generally bullish about the company’s long-term future, however. Its core business—social and mobile advertising—remains impressive and growing. (According to a report by eMarketer released in December, U.S. advertisers spent about US$9.3 billion on mobile ads in 2013, up more than 120% from the year before.)

Chart showing growth of mobile marketing

That’s the same reason the Snapchat scenario—wild as it might seem—isn’t necessarily crazy when you break it down. “Turning down $3 billion sounds insane,” says Neil Bearse, the associate director of marketing at the Queen’s School of Business, but not if you have the next hot thing. Snapchat has a proven record of attracting young, loyal mobile users; Facebook has struggled on mobile. So it makes sense for the latter to go after the former, even if the price might seem a tad too high.

Hype-laden social media startups are far from the only thing the tech sector has to offer. Less glamorous but more reliable businesses abound. Tony Olvet, the group vice-president for research at IDC Canada, says 2014 will be a big year for cloud computing as more and more enterprise customers get over their security fears. “What we’re seeing is the value and economics of cloud for most organizations outweigh the potential risks,” he says. That should open up new, valuable territory for app developers and others active in the cloud space. That’s not to say there aren’t business charlatans out there. Not every tech startup is destined for a profitable future. At the angel investor level especially, Bearse believes, “it seems like a lot of companies are getting funded, and it may not be sustainable.”

So while Silicon Valley’s hype bubble is overdue for a good poking, a few flameouts won’t spoil the whole party. Instead, we’re due for a gradual deflation of expectations—with a few spectacular blow-ups. In 2014, cooler heads will still find real growth. They’ll just have to look beyond the anointed social media darlings to get it.