Investigation of a new tech bubble

Hege Christoffersen & David Gulbrandsen

Student thesis: Master thesis

Abstract

Stock prices for technology companies reached astronomical levels in 1999/2000, resulting from market speculation. The high priced companies were characterized by low and even no earnings to speak of. This thesis investigates the listed companies represented in four technology heavy indices in the U.S. based on a variety of ratios with a goal to determine overvaluation. Compared to the overall stock market, these are priced at a higher level, though not as high as for the dotcom the period. The corresponding earnings may be explained by sounder business models for these companies in the current situation. Venture capitalists are eager to invest in technology due to the high growth and profitability opportunities. Venture capitalists` interests in technology are increasing, especially within the software sector and particularly for Internet related companies where social networking companies receive the highest investments. Based on IPOs being their most successful and profitable exit strategy, we find it plausible to assume that this increased interest will have a large impact on the public stock market. Due to the financial crisis, a lot of private equity companies failed to exit their investments, leaving the record high investment deals in 2005-2007 still queued to be disinvested. This pipeline shadow of IPOs is also likely to have an influence on the public market when the IPO window widens due to increased liquidity in the market. Due to the high valuation of companies soon to be listed, the thesis further investigates some of these companies within the Internet related company industry. LinkedIn went public recently, trading at a price earnings ratio of 1346 after the initial price surged from $45 to $94. 5, a 109 percent increase. This means that the transferred value of $388 million from LinkedInĀ“s existing shareholders to the new investors were made due to mispricing of the stock done by the company`s underwriters. The subsequent companies have either filed, or have said that they will file for an IPO within a short time frame; Groupon, Twitter, Zynga and Facebook. To be able to compare the companies under investigation, a price to sales ratio were computed, showing that all these companies had an over-valued market capitalization compared to the industry average. This may be a result of accepted overvaluation of these social networking companies due to a lack of benchmark companies, as this is a new type of industry. The valuations and venture capitalist investments in later stage of development, point towards a hot market for social networking and gaming companies within the sector of technology. The subsequent high demand for such companies when entering the public market, may lead to a bubble. The high demand may in turn be explained by media attention towards these companies, the celebrity stock effect, an under-pricing of the stock done by the underwriters, herd behavior and an increase of non-professional investors entering the market.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2011
Number of pages167