Every bubble has its ultimate deal, the craziest, mostest, farthest-outest acquisition. Hype mongers rave about it, experts explain it, financial gurus rationalize it. Head-shaking doubters are trying to come to grips with why classic metrics no longer apply, why paying a gazillion bucks for not very much or loading up the acquired company with an impossible mountain of debt is no problem, given the new realities of whatever mirages the dealmakers are seeing.
But you never know until afterwards which deal was the ultimate one that later would be described as having “marked the top.”
At that point, the craziness can no longer be exceeded. Buyers simply vanish. Sellers get desperate. The newfangled theories and metrics sink into a morass of ridicule. And lots of money goes up in smoke.
“I am not averse to paying six times sales for businesses that are growing fast if the end-margins are likely to be good,” John Hempton, Chief Investment Officer of Bronte Capital, wrote on his blog on Friday as he was mulling over Facebook’s acquisition of WhatsApp, a messaging app maker with 55 employees and $20 million in revenues.
Facebook, Google, and other tech stalwarts have been buying with their own sky-high shares, of which they can print an unlimited number, whatever they run into at whatever price, no questions asked. To them, money doesn’t matter because they’re printing their own. They’ve been gobbling up tiny outfits of this size by the dozen, and valuations have been soaring. In the process, they’re distorting entire markets. The effects spread into other parts of the economy as the suddenly beyond-belief rich start blowing their new-found billions. The housing bubble in Silicon Valley and San Francisco are proof. But even in this crazy environment, what sets the WhatsApp deal apart is the price: $19 billion for $20 million in revenues. Facebook is paying a multiple of nearly 1,000 times sales.
It “makes no sense to me,” said Hempton who “used to be an unremitting bull on the market.” You can just see him shaking his head. Facebook’s shares actually rose instead of getting pummeled. Which led him to conclude: “Clever people are doing things I don’t understand, and I am just feeling old and tired.”
So is this the deal that marked the top?
On Jan. 10, 2000, two months before the implosion of the dotcom bubble, dotcom hero AOL announced that it would buy old media mastodon Time Warner for over $160 billion, at the time the largest deal in US history. “The best evidence yet that old and new media are converging,” the New York Times pontificated. “It could be the Internet companies that do the buying and the old media that sell out,” is how the paper explained the phenomenon in its inimitable manner, rather than make mincemeat out of it. Experts applauded the deal. Financial TV shows gushed over it. Everyone realized just how much sense it made. Sure, the price was high, but what the heck, it would be worth it. There would be miraculous synergies. And the doubters were shoved aside.
Two months later, the party was over. And in 2009, after much bloodletting, Time Warner finally dumped AOL. That was the end of the deal that had “marked the top” of the dotcom bubble. It had wiped out $100 billion in shareholder money.
In October 2007, right at the peak of the last stock market bubble, and while the housing bubble was already imploding, TXU, the largest electric utility in Texas was acquired in a $47 billion masterpiece of Wall-Street engineering, masterminded by KKR, TPG Capital, and Goldman Sachs. It was the largest leveraged buyout in US history. The smartest of the smart money used $8 billion in equity and loaded up the utility with $40 billion in debt. They were hoping that the utility, which relied heavily on coal-fired power generation, would gain a competitive advantage over gas-fired power plants. These mind-boggling geniuses figured that the price of natural gas would skyrocket because the US would run out of it.
Then the stock market bubble imploded. Wall Street tycoons were bailed out, including the geniuses at Goldman Sachs. The shale-gas boom took off, creating a glut with natural gas prices crashing below the cost of production. Now, Energy Future Holdings, as the utility has been renamed, is fixing to file for Chapter 11 bankruptcy, the Dallas Morning News reported. Negotiations with creditors have been dragging on. If no deal can be reached, the utility will pull the trigger in late March or early April. That would be the end of the deal that “marked the top” of the last bubble.
Henry Blodget, co-founder and CEO of Business Insider, and erstwhile Wall-Street dotcom guru, who was “keelhauled … and booted out of the industry,” was waiting to go on air to talk with Charlie Rose about the Facebook-WhatsApp deal, when he ran into Steven Pearlstein, a Washington Post columnist, 2008 Pulitzer Prize winner, and George Mason professor. Blodget promptly reported their conversation:
Every big boom has its iconic market-top event, Pearlstein says. And he thinks the $19 billion that Facebook is shelling out for a company with $20 million of revenue, combined with the market’s immediate and startling celebration of this move (remarkably, Facebook’s stock went up on the news), will mark the top of this latest 5-year bull market.
And Blodget, who knows a thing or two about stock-market bubbles, conceded that there was “a chance that Professor Pearlstein might end up being right.”
Alas, along with the basic messaging app, Facebook got some complications for its $19 billion. WhatsApp co-founders Jan Koum and Brian Acton “despise advertising and value the privacy of their 450 million users so much that they do not even collect their names,” the New York Times reported. This would be in contrast to Facebook, which prides itself in purloining and monetizing every bit of personal data it can get its hands on. While both companies are furiously trying to reassure WhatsApp users that nothing will change, words are just words, and soon, Facebook will go after the users’ personal data – or at least, that’s what users get to fret about. Will they switch to one of the competing services? Many more apps will soon come to market, now that everyone has been whipped into a frenzy by the crazy valuation, from lonesome coders to large telecom carriers….
“When I explain that likely scenario – 50 major telecom companies rolling out similar services in the next few quarters – fellow portfolio managers, other contacts, and my clients, including some Silicon Valley pros, shrug as if I proposed some tail scenario,” a wealth manager told me.
As with the AOL-Time Warner deal or with the TXU deal, hype mongers rave about the Facebook-WhatsApp deal, experts explain it, financial gurus rationalize it, TV characters gush over it. Even doubting Blodget thought it “made sense for Facebook.” These kinds of deals simply have too much momentum. Speak out against them at your own peril. This too is a characteristic of a topping bubble.
“That we’re repeating this error for the 3rd time in 15 years shows the existence of a serious dysfunctionality in our financial system,” the wealth manager mused. “The checks and balances are not working properly. This is the serious take-away.”
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.