We're in a world where venture capital flows to companies without clear sources of revenue, Facebook buys apps for billions and Twitter is a publicly traded company. Amid this status quo, David Einhorn, president of Greenlight Capital Inc., wrote an ominous letter to investors warning of the growing tech bubble and what might "pop" it.
Einhorn, as one may remember, gained a deal of notoriety for his dealings with Allied Capital, and, of course, for short-selling Lehman Brothers and very publicly calling out its fuzzy practices. (At the 2008 Ira W. Sohn Investment Research Conference he called for federal regulators to “guide Lehman toward a recapitalization and recognition of its losses—hopefully before federal taxpayer assistance is required.”)
Now he has a different warning: an expanding tech bubble. Though he doesn't name any specific companies, according to the Wall Street Journal, he is particularly worried about three specific issues. They are the "rejection of conventional valuation methods," huge first day IPOs and "short-sellers forced to cover due to intolerable market-to-market losses."
Einhorn is not the only market-watcher worried about the growing tech bubble and how it might burst. Venture capitalist George Zachary went on Bloomberg West earlier this month and warned of a bubble. In March, Canadian research firm BCA Research managing editor and chief strategist Chen Zhao wrote to his clients about bubblelike conditions.
A portion of Einhorn's letter can be viewed below via ValleyWag:
"We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it's still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year. Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it.
In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm.
Some indications that we are pretty far along include:
- The rejection of conventional valuation methods;
- Short-sellers forced to cover due to intolerable mark-to-market losses; and
- Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.
And once again, certain "cool kid" companies and the cheerleading analysts are pretending that compensation paid in equity isn't an expense because it is "non-cash." Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?"
The entire letter can be viewed below via Scribd: