The new tech bubble takes us to a new world. A mad world.

Larry Kummer, Editor

10 years ago

Summary: As we enjoy the third bubble in 15 years, watching America’s investment capital burn away, let’s break loose from the crowd and seek a more accurate perspective. However bleak the vision, never ask for the blindfold.

Contents

Our odd third bubble
Peter Schiff asks “WhatsApp With That?”
About the author
For More Information

(1) Our odd non-investment bubble

“Hegel says somewhere that all great historic facts and personages occur twice, so to speak. He forgot to add: ‘Once as tragedy, and again as farce.’”
— Opening line to Karl Marx’s The Eighteenth Brumaire of Louis Bonaparte (1869)

Investment bubbles are an inherent aspect of free market economic systems. They predate central banks, fiat currency and modern fractional reserve banking systems (despite conservative mythology). They leave both losers and the infrastructure they built (e.g., canals, railroads, the Internet).

The two previous bubbles are oddly recent, but otherwise typical. The current one is not. First, three bubbles in 15 years suggest either amnesia drugs in the water or a people with a dysfunctionally-serious inability to learn. Second, despite the claims, this is not a tech bubble. The technology involved is only slightly advanced, the resulting companies mostly unprofitable, and the key products are stock certificates. The massive customer growth results from underpricing (there are always takers when selling dimes for a nickel), the funds come from the venture capital – investment bank – investment management industry. They, and the senior managers of these companies, will keep their profits when the investors’ money vanishes with last year’s snow.

This is half of America’s seed corn. Poured into what are little more than ponzi schemes, whose collapse will leave little behind. (The other half of our seed capital feed our military and intelligence machinery. The resulting flames are pretty, but accomplish little).

Let’s correctly assign responsibility for this. All cons require suckers. Our amnesia makes us perfect for that role in this game.

“You can’t cheat an honest man.”
— W. C. Fields movie (1940)

(2) A look at the latest chapter in our mad adventures

“WhatsApp With That?”
By Peter Schiff
From EuroPacific Capital, 22 February 2014
Reposted here under their Creative Commons license

Two pieces of business news announced this week provide a convenient frame through which to view our dysfunctional and distorted economy.

The first (which has attracted tremendous attention), is Facebook’s blockbuster $19 billion acquisition of instant messaging provider WhatsApp.
The second (which few have noticed) is the horrific earnings report issued by Texas-based retail chain Conn’s {see Reuters}.

While these two developments don’t seem to have much in common, together they shed some very unflattering light on where we stand economically.

Given the size and extravagance of the Facebook deal, it may go down as one of those transactions that define an era (think AOL and Time Warner). Facebook paid $19 billion for a company with just 55 employees, little name recognition, negligible revenues, and little prospects to earn much in the future.

For the same money the company could have bought American Airlines and Dunkin’ Donuts, and still have had $2 billion left over for R&D. Alternatively they could have used the money to lock in more than $1 billion in annual revenue through an acquisition of any one of the numerous large cap oil producing partnerships. Instead they chose a company that is in the business of giving away a valuable service for free. Come again?

Mark Zuckerberg, the owner of Facebook, is not your typical corporate CEO. Through a combination of technological smarts, timing, luck, and questionable business ethics, he became a billionaire before most of us bought our first cars. And in the years since social media became the buzzword of the business world, Wall Street has been falling over backward to funnel money into the hot sector. As a result, it may be that Zuckerberg looks at real money the way the rest of us look at Monopoly money. It also helps that a large portion of the acquisition is made with Facebook stock, which is also of dubious value.

But even given this highly distorted perspective, it’s still hard to figure out why Facebook would pay the highest price ever paid for a company per employee — $345 million (more than four times the old record of $77 million per employee, set last year when Facebook bought Instagram). The popular talking point is that the WhatsApp has gained users (450 million) faster than any other social media site in history, faster even than Facebook itself. Based on its rate of growth, the $42 per user acquisition cost does not seem so outrageous. But WhatsApp gained its users by giving away a service (text messaging) for which cellular carriers charge up to $10 or $20 per month. It’s very easy to get customers when you don’t charge them, it’s much harder to keep them when you do.

Boosters of the deal expect that WhatsApp will be able to charge customers after the initial 12-month free trial period ends (it now charges 99 cents per year after the first year). Based on this model, the firm had revenues of $20 million last year. But what happens if another provider comes in and offers it for free? After all, the technology does not seem to be that hard to replicate. Google has developed a similar application. More importantly, no one seems to be projecting what the cellular carriers may do to protect their texting cash cows.

WhatsApp gives away what AT&T and Verizon offer as an a la carte texting service. As these carriers continue to lose this business we can expect they will simply no longer offer texting as an a la carte option. Instead it will likely be bundled with voice and data at a price that recoups their lost profits. If texting comes free with cell service, a company giving it away will no longer have value. People will still need cellular service to send mobile texts, so unless Facebook acquires its own telecom provider, it can easily be sidelined from any revenue the service may generate.

Some say that texting revenue is unimportant, and that the real value comes from the new user base. But how many of the 450 million users it just acquired don’t already have Facebook accounts? And besides, Facebook itself hasn’t really figured out how to fully monetize the users it already has. In other words, it is very difficult to see how this mammoth investment will be profitable.

From my perspective, the transaction reflects the inflated nature of our financial bubble. The Fed has been pumping money into the financial sector through its continuous QE programs. The money has pushed up the value of speculative stocks, even while the real economy has stagnated. With few real investments to fund, the money is plowed right back into the speculative mill. We are simply witnessing a replay of the dot com bubble of the late 1990’s. But this time it isn’t different.

In another replay of that spectacular crash fourteen years ago, the appliance and furniture retailer Conn’s has just showed the limits of a business built on vendor financing. In the late 1990’s telecom equipment companies almost went bankrupt after selling gear to dot com start-ups on credit. For a while, these “sales” made growth and profits look great, but when the dot coms went bust, the equipment makers bled. Conn’s makes its money by selling TVs and couches on credit to Americans who have difficulty scraping up funds for cash purchases. For a while, this approach can juice sales. Not surprisingly, Conn’s stock soared more than 1500% between the beginning of 2011 and the end of 2013. These financing options are part of the reason why Conn’s was able to keep up the appearance of health even while rivals like Best Buy faltered in 2013.

But if people stop paying, the losses mount. This is what is happening to Conn’s. The low and middle-income American consumers that form the company’s customer base just don’t have the ability to pay off their debt. The disappointing repayment data in the earnings report sent the stock down 43% in one day.

In essence, Conn’s customers are just stand-ins for the country at large. In just about every way imaginable, America has borrowed beyond its ability to repay. Meanwhile our foreign creditors continue to provide vendor financing so that we can buy what we can’t really afford.

So thanks for the metaphors Wall Street. Too bad most economists can’t read the tea-leaves.

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(3) About the author

Peter Schiff is the founder, CEO, and Chief Global Strategist of Euro Pacific Capital. He is known for his vocal and unpopular bearish views of the U.S. economy, voiced prior to the 2008 financial crisis, many of which were outlined in his 5 bestselling books.

He is the host of the syndicated “Peter Schiff Show”. His weekly commentaries appear here. See Wikipedia for more information.

His books:

Crash Proof: How to Profit From the Coming Economic Collapse (February 2007)
The Little Book of Bull Moves in Bear Markets: How to Keep your Portfolio Up When the Market is Down (2008)
Crash Proof 2.0: How to Profit From the Economic Collapse (2nd Edition, September 2009)
The Little Book of Bull Moves, Updated and Expanded: How to Keep Your Portfolio Up When the Market Is Up, Down, Or Sideways (2010)
How an Economy Grows and Why it Crashes (2010)
The Real Crash: America’s Coming Bankruptcy — How to Save Yourself and Your Country (2012)