Beyond Face Value

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By Lior Alkalay
eToro Senior Analyst

This generation takes the Internet for granted; they never knew a day when you could not connect to the rest of the globe with merely a mouse click. But for those of a certain age, it’s a stroll down memory lane to the days when the concept of an interconnected world was first introduced. It was at once incredible and incredulous. Through this thing called the “world wide web” we could send emails, shop, conduct business, get instant news updates, etc., without stepping a foot out of doors.

And it was the visionaries of Silicon Valley, California whom the world can thank. They introduced the notion that an intangible idea had not only had value, but was bankable; start-ups raised millions of dollars just that way. Wall Street loved it, and the NASDAQ exchange, which listed the majority of tech companies, skyrocketed, gaining 500% in two years.

And then the dot.com bubble burst. The shooting star that was the tech companies fizzled then burned out as investors questioned a business plan that was based solely on a dream. Investors wanted tangible evidence – reliable models with real cash flow plans drawn up by someone with an MBA, not a geek with a computer. 

Flush with cash, where better for investors to put their money after the inevitable stock market collapse but back on the backs of the industry that built Wall Street up in the first place – the banking sector. The NASDAQ had crashed and burned with the dot.com bust, and remained stagnant even as the Dow and the S&P 500 steadily recovered. The financial sector, with its banks, investment firms and stock brokers became an even larger part of the American economy.

Despite an inherently conservative nature, banks engorged themselves with leverage, certain that the best brains money could buy would shield them from risks, and so they took more and more of them, eclipsing even those taken by the tech companies in Silicon Valley. A bubble was being built there, too, and of course, it was unsustainable. With all that leverage and all those risks something had to give; the result was the financial crisis of 2008-2009.

And while all that was happening on Wall Street, the geeks from Silicon Valley thought about the lesson they’d been taught and learned from it. They retained their dreams, but now knew how to present a credible business model. In essence, the geeks grew up into businessmen, wearing as their uniform jeans, a hoodie and a laptop. And while Wall Street’s traditional designer suit-wearing businessmen were preoccupied with new regulations, bailouts and deleveraging, Silicon Valley’s “businessmen” polished up their business models and grew a “new” type of economy.

In the past, Wall Street’s influence was all-powerful, but that is no longer the case. The financial sector is valiantly, perhaps fruitlessly, trying to restore its credibility to the public who were incensed by their greed and recklessness. And the former kids from Silicon Valley, who were summarily dismissed after the dot.com bust, not just rekindled but commanded investors’ attention.

And there you can see it clearly – a fundamental shift in the balance of cash and power and leadership; Wall Street bows out as Silicon Valley storms in. And the tech storm will build, especially as the social media sector releases more and more of its enormous growth potential. LinkedIn and Groupon and Zynga may have been the tip of the social media iceberg, but Facebook is not the rest of it – certainly, there’s much more beneath the surface ready to emerge. Will Facebook, LinkedIn, and the social networks revolution will become a success and transform the economy for good? Some investors are skeptic outlining social networks have yet to prove their ability to deliver the bottom line which is measured in Dollars not in "Likes". Are they right or wrong? Time will tell but as I will soon explain, from an investor point of view on the overall scheme of things, this does not really matter.

Beyond the Facebook IPO

Today investors witness the highly expected Social IPO of Facebook (FB) with the company issuing stocks with a value of $104Bln with shares barley holding and only issuers' intervention keeping the stock afloat above its open price. Nevertheless and as much as Facebook's IPO is a big event, it is a mere dot in the overall picture. There are moments in time where the stock markets starts to open a real bullish cycle and this usually happens when there are two combinations, cheap money and big IPOs.

When both are combined there starts a process where on the one hand investors seeking higher returns are ready to invest in more speculative ideas and on the other hand big "sexy" IPOs feeds their hunger and attacks big funds inflows. And then, steps in the game changer, the one element that is tipping the balance towards a big shift. The excitement and buzz around big IPOs brings the broad public to stocks and pushes market valuations to rise beyond multiyear ranges.

Tech stocks are indeed the most attractive sector. At the moment they are cash rich, their outlook looks good and their growth in leading to a more efficient economy, a sort of an "industrial revolution." This sense of industrial revolution has already occurred once in the tech sector, in fact this brings me to my first economic lesson, the dot.com bubble. As illustrated in the chart above, just before the happy dot.com times we had big IPOs such as EBay (EBAY) and Yahoo (YHOO). Now we have LinkedIn (LNKD), Zygna (ZNGA) and of course Facebook. What makes retail clients, the so called broad public to start participating and pull techs into new highs? It is their ability to relate to the buzz social networks and get into the euphoria, that illusion that the sky is the limit for those stocks.

How Investors Ride The Storm

Investors on their point of view see this as a pure opportunity to bank in on the public euphoria. Most investors and I am among them, might find it hard to price the fair value of each social stock and are rather unsure which among them provides the most added value. Looking at the Nasdaq composite however is a different story. The Nasdaq contains on the one hand cash rich companies such as Intel and Google while it is also likely to contain most of the big Social IPOs. When Adding up the Nasdaq sharp correction in May towards the 2,700-2,800 zone, the positive outlook of most tech companies and the historical behavior of the index when the last euphoria took place and it brings investors to expect a big bullish cycle in the Nasdaq. The fact that the Nasdaq corrects and rises more cautiously unlike the rally in 1999-2000 only provides the tech rally a stronger footing and investors the confidence they need to push the index higher and higher with the bubbly territories of 2000 still in the distant horizon. 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks , Investing Ideas , IPOs

Referenced Stocks: EBAY , FB , LNKD , YHOO , ZNGA

Lior Alkalay


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