In Search of the Perfect Investment

Nice piece of optimism from BTIG:

Q3 earnings season is roughly half over and at the risk of repeating ourselves, earnings are going “well enough.” In fact, we’ll go a step further and say that while revenues are coming in roughly in line with expectations, EPS are doing a bit better, growing about 4-5% from one year ago. That is at the upper end of the 3-5% range seen the last few quarters. We’ll have to wait until the quarter’s completion (or at least the end of next week) to appropriately gauge the full impact of share count reductions (the companies that have already reported have a cumulative share count reduction of about 0.5%) but thus far, the increase in earnings continues to justify higher stock prices.

Should be continue to be good for stocks like MA, V, GOOG and AMZN.

I moved Susan’s contacts, calendar, email, messaging, etc. from her old iPhone 4s to her new iPhone 5S. The move wasn’t painless, but was successful. The 5S is a remarkable phone. Speed is the big plus. Everything is much, much faster. That makes for a really nice “user experience.” Check out “The iPhone 5S’s Graphics Are Insane” here. Later today, Apple plans to conduct a conference call to discuss financial results of its fourth fiscal quarter on Monday, October 28, 2013 at 2:00 p.m. PT / 5:00 p.m. ET. Listen to the conference call here.

It’s been a hot year for IPOs. Here are the hottest ones of the past six months (courtesy Yahoo):

Here are the coldest ones of the past six months, also courtesy Yahoo:

More on Yahoo here.

Are tech startups overvalued? This is game that’s very expensive to play, but has potentially huge rewards — like ten and twenty times on your money. Once again you have to throw normal metrics out the window — like earnings. It’s a game you don’t see Warren Buffet playing. Bit it IS fascinating.Here’s a weekend New York Times piece on the phenom (fancy talk for phenomenon). 

Disruptions: Are Eager Investors Overvaluing Tech Start-Ups?

Pinterest is a kind of Internet message board where people post their favorite images of clothes or furniture. It’s a three-year-old company and though it has an estimated 50 million unique monthly users, it doesn’t have any revenue yet.

Still, the investors behind a $225 million round of financing that was announced last week estimated the company’s value at $3.8 billion.

To put that in perspective, the estimated value of Pinterest, based in San Francisco, is about a third of Twitter’s. The micro-messaging service could have $600 million in revenue this year (though it isn’t profitable) and is set to go public in a few weeks.

Even in Silicon Valley, where financiers don’t often let pesky business measures like revenue and profits dampen their enthusiasm for a start-up, Pinterest’s new financing seemed like a reach.

So why the eye-popping numbers? A pessimist would say more big money finding its way to tech start-ups is a sure sign of an investment bubble, because Pinterest is hardly the only young company landing huge investments.

This year, Fab, the designer e-commerce site that hasn’t made a profit, increased its valuation to $1 billion by taking a $150 million investment from the Chinese Internet conglomerate Tencent Holdings. This month, Alibaba Group Holding, a Chinese e-commerce company, led a $206 million investment in ShopRunner, which offers unlimited two-day shipping from retailers, that valued the company at $600 million.

On Friday, AllThingsD reported that Snapchat, the messaging app based in Los Angeles, which also lacks revenue, is weighing a “huge” investment round that would value it at $3.5 billion.

At the very least, that’s a frothy list that argues enthusiasm is once again getting ahead of reality in the tech industry.

The Pinterest investment is also an opportunity to see how big, outside money is added to the mix in Silicon Valley. While the latest Pinterest round included Valley heavyweights like the venture capital firm Andreessen Horowitz, the bulk of the money came from Fidelity Investments, the mutual fund giant in Boston.

And Fidelity plays by different rules than the typical tech investor.

Cash-rich financial outfits like Fidelity, which has more than $1.7 trillion in managed assets, are not as worried about hitting the home run ball as typical tech investors. Double your money when you invest $200 million? That’s fine for Fidelity. And if the investment doesn’t work out, it’s still minimal for a company that large.

That would never do for venture capitalist firms. First, they can’t throw around that kind of money. Second, those firms typically promise their own backers a return 10 times or more on the money they’ve put into a company. They have to. Many of the companies they put money into never pan out, and they’re always looking for the next Facebook or Google to make up for the numerous bad bets.

Venture capital is a high-risk business. As risky as throwing $200 million at a company with no revenue? It’ll be a while before we know the answer to that one.

Likewise, when foreign financiers put money into start-ups, they’ also don’t look for huge returns. Following the lead of Yuri Milner’s investment company, which put money into companies like Facebook and Twitter, they also have more modest goals: turn a profit, improve their cachet among the start-up community and – as is often the case – learn from the companies in which they are investing.

“It depends on the glasses you’re wearing whether these investments are too high,” said Mark Leslie, a managing partner at his own venture firm, Leslie Ventures, and a lecturer at the Stanford Graduate School of Business.

Fidelity declined to comment on its investment. Pinterest said it was using the money to invest in the core of the company and international expansion, but would not discuss the valuation.

Now the idea of Silicon Valley’s investment community – which brought you Pets.com and other Web wonders – wagging fingers and noting that others are driving irrational valuations might strike some people as, well, funny. Or sour grapes.

But start-ups court risk when they lure investments at such generous valuations. As I’ve written before, once a start-up reaches a $1 billion valuation, they limit the number of big companies capable of acquiring them.

Of course, it can be difficult to say for certain how much a young company should or should not be worth. Private investors may gamble that a fast-growing start-up with no obvious revenue may figure out, as Google did, how to pair a smart business model with millions of users.

That said, it can be hard to figure how these valuations add up.

Take Square, the mobile payments start-up best known for its slick credit card reader. Last year, it raised a reported $200 million from investors that valued the company at $3.25 billion.

Square is expected to process $15 billion in transactions in 2013. Compare that with MasterCard, which processes more than $3.6 trillion in credit card transactions annually. MasterCard is valued at $90 billion on the public market. If the market were applying valuations based on transaction volume alone, MasterCard would be valued at almost $800 billion.

Not surprisingly, “unlike Square’s previous financing rounds, which prominently featured big venture capital names like Sequoia Capital and Kleiner Perkins Caufield & Byers,” its most recent round was not led by a traditional Silicon Valley backer, The New York Times reported at the time.

Instead, the majority of the financing came from Suhail Rizvi, the head of Rizvi Traverse Management, a private equity group. Rizvi Traverse and Square both declined to comment about the company’s financing.

Does Mr. Rizvi, who is also among Twitter’s biggest investors, have a greater appetite for risk than tech’s usual financiers? Perhaps.

Or maybe, as Mr. Leslie put it, he’s looking at his investment with a different set of glasses.

My favorite Wikipedia factoid

Cut flowers
Israeli and Australian researchers discovered that 1 mg of the drug dissolved in a vase of water can extend the shelf life of cut flowers, making them stand up straight for up to a week beyond their natural life span.

My favorite weekend quote

From a story titled, “The Harvard Doctor Who Accidentally Unleashed a Zombie Invasion.”
You can find evidence for nearly anything that scares you if you simply look for that evidence online. An illegitimate president fudging his birth records? A grand conspiracy to topple the twin towers and blame terrorists? A frightening link between vaccines and illnesses? “Proof” of all this and more is only a Google search away.

Social psychologists note that in game situations, the more outlandish the bluff, the more likely it is that the bluff is taken seriously. The human interpretation of a giant fib seems to be that the apparent mistruth wouldn’t be worth telling – that being caught in the lie would not be worth the risk of being caught – unless the lie were in fact true. As the mathematician Blaise Pascal once said, “We want to be deceived.”

To be sure, conspiracy myths and mass hysteria were not invented with the Internet. But the online world allows a tiny spore of ridiculous conjecture to mushroom quickly into a widely disseminated belief. This happens, in part, because you often go to the Internet to look for information that confirms your pre-existing mythologies. This is what social and cognitive psychologists call “confirmation bias” – the idea that, if you have a preconception, you will selectively examine the available evidence to support that belief. Perhaps worse, you will selectively ignore the evidence that challenges your convictions.

The Internet is in many ways designed to amplify this bias – not just temperamentally but technically. For example, if you use my computer to search the word “food,” the very first jpeg that a Google Images search yields is an electron micrograph of salmonella. But if I were to use someone else’s laptop – someone who didn’t use his computer to write about zombies and infection and food-borne illness – I’d more likely get a photograph of pizza or a salad. To this end, the Internet recycles your own preconceptions, even in the guise of a seemingly random inquiry. It scares you with what it thinks you want to know.

There are other aspects of media-generated hoaxes and panic that are worth noting. Those who studied the “War of the Worlds” fiasco noted that the apparent authority of a well-known figure like Orson Welles, coupled with the modality of radio (the major means by which information was transmitted at the time), lent credibility to what would otherwise have been received as science fiction. (Imagine, by contrast, if a random person ran screaming toward you on the street, saying that Mars was invading Earth.) Additionally, the Great Depression and the looming, free-floating anxiety of World War II proved to be fertile soil for panic. The public was waiting for something in which they could situate their already present fears.

This means that we’re more likely to believe a fictional account told by a reputable source using a modality through which many people receive their news, especially in the context of the uncertainty characteristic of modern times. Voilà! A Harvard physician talks about zombie infection on the radio during a time when we can’t open a newspaper without reading about pandemic flu or the risk of mercury in our fish oil, and then the Internet confirms every fear of zombies that anyone ever harbored, supported by references to the very doctor who was just on the radio.

One of my favorite examples of this phenomenon did not create panic but did dupe a good deal of smart people. Use the Google Trends tool and query “male pregnancy.” You’ll note a fairly impressive spike between 2007 and 2008. This is roughly the time that the first male pregnancy was reported at the world-famous Dwayne Medical Center. Word of this amazing medical achievement spread virally online.

Except there is no Dwayne Medical Center. And of course, there’s no male pregnancy among humans. The entire Web site celebrating the scientific achievements of the Dwayne Medical Center is a hoax. It was created by a multimedia artist named Virgil Wong. He brought to his Web site the very same elements that were associated with public belief that Martians were attacking back in 1938. His Web site for Dwayne Medical Center looks very authentic. It mixes popular modalities of media in an impressively seamless digital montage. The pregnant man, for example, is featured in the Web site on the cover of a doctored U.S. News & World Report.

For those who are Internet savvy, the story of this hoax is old news. Still, it isn’t that hard to show this site to people naïve to the story and get them to believe it. As the noted skeptics Agents Mulder and Scully might suggest, the truth is out there. But when you search for it online, the truth may turn out to be whatever you need it to be.

For the full story (this is actually the full story), click here.

Weekend reading.

+ Nobody Should Shed a Tear for JP Morgan Chase, by Matt Taibbi. Conclusion:

These guys at Chase knew exactly what they were buying when they took on these companies (Washington Mutual and Bear Stearns) . They just thought they were getting the deal of the century, by taking on the still-functioning businesses of two finance giants for a song, giving Chase a state-subsidized push into the pole position of American banking. And they figured, very nearly correctly, that they would never have to pay any serious freight for all the offenses committed by their new acquisitions.

Now they’ll have to write a big check, which sucks for them, but what about the victims? To those critics crying about a “shakedown”: Would you prefer that Chase merely be required to pay back every dollar to those investors wiped out by these schemes? Because that would be a hell of a lot more than $13 billion.

It would be great if everyone covering Wall Street could sign a pact, and agree: No more crying, please, about no-jail, no-individual-penalty settlements in which companies use shareholder money to pay fines at huge discounts relative to the actual damage they caused. And again, wake me up when even one of these guys goes to jail. There are only about a million Americans doing time for less.

For the full Taibbi piece, click here.

Harry Newton learned that a good safety measure is to turn off your faucets going to your washing machine when you leave the house. Save it flooding the house when you’re away.