Bubble, bubble, bubble. Investors heard the word last year as U.S. markets continued their incredible run. Their performance this year – more record highs, seemingly day after day, means investment commentary is awash in the "b word."
There's plenty of evidence to suggest there's no bubble in the broader market: Various price-to-earnings ratios are above historical averages, but not terribly so. And, anecdotally, there's a lack of cocktail-party stock chatter that suggests individual investors have jumped in wildly. Certain types of tech-industry stocks trade at such sky-high levels, however, that it's a lot easier to suggest there's some speculative fever out there in sub-sectors of the market.
Want to argue the bubble case? Consider Castlight Health Inc., a company that helps employers sort out the U.S. health care system via the Internet. It went public Friday, pricing its shares at $16 (U.S.) apiece, then trading as high as $41.95.
It has retreated to $31.50 since then, but even a 25-per-cent decline isn't enough to make the shares look like anything resembling a deal. The company had a market capitalization of $2.7-billion at the end of Wednesday, versus $13-million in revenue in the past 12 months and a $62-million loss. As multiples go, that's 200 times sales, making it, easily, the most expensive stock on the New York Stock Exchange.
Aaron Pressman, a veteran technology writer at Yahoo Finance, called it "the most overpriced IPO of the century," citing data from a University of Florida professor who observed that the investment bankers' price of $16 a share valued the company at more than 100 times sales, a level not seen for a tech IPO since 2000.
Castlight's business is based on a solid premise: The U.S. health care system is maddeningly complex, and the move to make patients and their employers more responsible for the cost requires better, more transparent information. The trouble, as Mr. Pressman says, is that Castlight isn't the only one to figure this out, and many major insurers are rolling out similar offerings, free of charge, to their customers.
Castlight is benefiting from the awesome performance of so many other "cloud" stocks, companies whose story is based on selling computer services over the Internet, rather than through some mix of clunky hardware and software at their customers' sites. Many cloud stocks have doubled or tripled in the past year, suggesting that any company merely needs to spin this tale to achieve obscene valuations.
Except, isn't one of the signs of a bubble that any company, regardless of potential fallacies in its business plan, zooms right up to the stratosphere if it says the magic words? If you want to argue against the bubble scenario, I give you … Chegg.
Chegg Inc. went public last November, saying it would ultimately use the cloud to empower college students to take control of their education. In reality, the company rents textbooks, more of them old-fashioned bound copies than digital, through an online portal.
Investors did not sweep up Chegg in any sort of cloud frenzy, it must be said: The company priced its shares at $12.50 apiece, and the stock never once traded on the open market at that level, at one point sinking to less than half the IPO price. Perhaps there's a level of discernment to investors' tastes that they're not being given credit for – and that speaks against a bubble.
Perhaps, then, a tiebreaker? Let's see what happens to King Digital Entertainment PLC, which plans an IPO this week and could be trading as early as Thursday.
The maker of the Candy Crush game app (with nearly 100 million players) went into Wednesday with the intention of pricing shares at $24 apiece. That would value the company at $7.6-billion – which, actually, isn't so bad for a company with $1.9-billion in revenue, net income of $568-million and operating cash flow of $680-million in the past 12 months. Yahoo's Mr. Pressman, interestingly, calls it "undervalued."
I was similarly intrigued in 2011 by the numbers put up by prepublic Zynga Inc., creator of the Farmville game on Facebook. It was an even better generator of cash per dollar of revenue, actually.
Past tense, of course. Zynga has been a dud since its IPO. People may say "this time it's different," of course, because Zynga was overly tied to one partner, Facebook Inc., which ultimately restricted access to its data and began to promote other game companies. Zynga also didn't figure out mobile gaming the way King Digital has.
Will investors place a big bet that the creator of Candy Crush has a long-term, cash-generating franchise, when a nearly identical company has already crashed and burned? If King Digital shares double or triple in the coming hours, days and weeks, well, expect to keep hearing that "b word," probably with some justification.
David Milstead