Nothing from nothing equals nothing . . . if Billy Preston could see the Facebook debacle coming, why couldn’t you?

Come on people . . . IPOs have and always will be the equivalent of fool’s gold! Never, ever invest in a just launched IPO . . . wait a few months or longer and then do your homework after the purported hype. I mean did you not read the article predicting that Facebook would not be around in 5 years (remember MySpace?).

Or to put it another way, those who invested in Facebook got exactly what they paid for . . . hype over substance.

Let’s move this discussion beyond the anecdotal reference of a Facebook and see what history tells us relative to whether or not IPOs are a good investment.

Based on one analysis by Professor Jay Ritter from the University of Florida, it would appear that the combination of a shell-shocked Wall Street, venture capitalist greed for a high valuation and the inclination of investors to overlook solid financial performance in favor of market hype would appear to be a recipe for disaster.

The Wall Street Factor?

According to Ritter, “Until the institutional trading desks on Wall Street crawl out of their bomb shelters and begin to entertain the idea of moving their field of vision beyond the latest financial disaster that has shaken their traditional foundations, the IPO market will limp along slowly.”

While Silicon Valley VC’s are quick to shrug off the Facebook controversy – and why wouldn’t they because they are the one’s who make a great deal of money from the IPO being issued as opposed to its performance afterwards, I am not certain that either Wall Street or the investor market has a high tolerance for unsubstantiated evaluations.

This is especially true given the current economic crisis and the growing cynicism tied to what Wall Street guru Natalie Pace referred to as crony capitalism.

Can you say Groupon . . .

Venture Capitalists and the Gekko Factor

Before we look to hang the Silicon Valley VC’s from the nearest yardarm I think that it is important to understand the inherent risks they face in making an investment in an enterprise.

Back in the late 90s when yours truly sold his software company for $12 million, our VC-oriented lawyer provided me with a sobering statistic.

As it turns out, out of every 10 companies in which a VC invests, 7 fail in that they lose their money, 2 deliver some return which at best is usually a break-even proposition, while just 1 – that’s right just 1, actually pays a positive return.

It is through these numbers that the needed understanding about IPOs (including the reason why one should not touch them with a ten foot pole) is gained.  The latter is especially true when dealing with high tech offerings in which there is no discernible revenue stream.

The truth of the matter is simply this, when an IPO is issued you have the overwhelming imperative of a VC’s need to capitalize on the 1 opportunity in 10 to make back the money lost on the other 9.  Add into the equation uniformed investor greed and you have the makings for a disaster . . . or in this instance Facebook.

Within the above context, it is not the VC’s who are at fault.  Although improprieties such as the ones being bandied about regarding the Facebook offering in which information regarding diminished revenue streams was made available to a select few insiders, do factor into the equation.

Honestly I believe that it is the uninformed public trying to cash in a on a quick payday who are truly at fault.  This is particularly true when people who have no business investing in the markets do so.

You only have to look at the dot.com boom and subsequent bust for hard lessons learned that it now appears everyone has forgotten.

I can still vividly recall seeing individuals who worked at the company’s loading dock rabidly scanning their computers to check up on the latest get rich quick high tech darling.  I was at once reminded of the rows of slot machines at the local casino with players hunched over the one-armed bandits in greedy anticipation of jackpots that rarely materialized.

Of course who could blame them for wanting to get in on the action as  tens of thousands of dollars were being made daily.  However, when you bet money in a volatile market that you cannot afford to lose, your actions border on being irresponsible rather than opportunistic.

. . . we earrrrn it!

Manufacturing Value as Opposed to Earning Value

I love the old Smith Barney commercial with John Houseman who in his distinguished voice proclaims “we make money the old fashioned way . . . we earrrrrn it!”

It seems that in today’s world of self-proclaimed entitlement the concept of actually earning money or accumulating wealth is foreign to many people.

Think I am being a little judgmental or harsh here?  Perhaps, but here is the thing; If investors really did their homework, they would soon discover that “nothing from nothing equals nothing” (thank you Billy Preston).  When you have companies such as Facebook and Groupon entering the market with low revenues and high valuations, warning lights should immediately go off.

After all, would a bank loan someone money to buy a house if they had little or no income coming in?  Okay, that’s a loaded question and a discussion for another day, but you get my point.  The share price of IPOs issued under these circumstances are based on nothing more than unbridled optimism and greed.

Unfortunately, and as long as the public is willing to drink the smoke and mirrors valuation Kool-Aid, they are going to get what they deserve . . .

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About piblogger

Author and Host of the PI Window on The World Show on Blog Talk Radio. View all posts by piblogger

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