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Snapchat was founded by Stanford fraternity brothers Bobby Murphy, left, and Evan Spiegel.

Los Angeles Times,

Social media start-ups' value is enormous, if you trust investors

  • Article by: Jessica Guynn
  • Los Angeles Times
  • November 20, 2013 - 8:34 PM

 

– Snapchat is not even three years old. It’s run by a couple of 20-somethings with no prior business experience. And it has never made a cent.

Yet investors are fighting for the opportunity to throw hundreds of millions at the mobile messaging service that is all the rage with teens.

The tiny Venice Beach, Calif., start-up just turned down a $3 billion all-cash offer from Facebook Inc. And then, according to the Silicon Valley rumor mill, it rejected an offer from Google Inc., this one for $4 billion.

That’s a big pot of cash for a smartphone application that could vanish almost as quickly as the messages people send on it.

Snapchat Inc. is just one of several young tech start-ups with no revenue and no profit that are commanding valuations that rival those of long-established companies such as Domino’s Pizza Inc., JetBlue Airways Corp. and Sotheby’s.

Among the better-known Silicon Valley companies with monster-truck-sized valuations are mobile payments start-up Square Inc. at $3.25 billion, online storage start-up Dropbox Inc. at $4 billion, private transportation service Uber Technologies Inc. at $3.5 billion and home rental service Airbnb Inc. at $2.5 billion.

These sky-high valuations for companies with untested business models are giving some people a bad case of dot-com déjà vu.

The tech industry may not be in another bubble, said Aswath Damodaran, professor of finance at the Stern School of Business at New York University, referring to the rapid rise and fall of Internet companies in the late 1990s and early 2000s. But these paper valuations are a “form of delusion,” he said.

What is pushing up the price tags? The ability of these companies to draw a fast-growing following of young users, analysts say.

Technology giants are willing to spend large sums of money buying these start-ups to keep up with young people’s rapidly evolving online habits. And investors are looking to place early bets on what could turn out to be the next Facebook or Twitter Inc.

Take Pinterest Inc., whose service people use to post images of their favorite things — outfits, home design, recipes, vacation spots — to share with friends.

The San Francisco company just raised $225 million from investors, valuing it at $3.8 billion — up from $2.5 billion in February.

Like many other start-ups, Pinterest has tens of millions of users, some of whom spend hours a day on the service, yet it has just begun to explore how it will make money, which means it could be years before it turns a profit.

Still, although valuations in Silicon Valley are clearly inflated, they may not be as bubbly as they sound, some experts say.

Twitter is just the latest social media company to show it can make money from its massive audience. And its successful initial public offering — it ended its first day of trading with a $25 billion market cap despite never having turned a profit — has whetted investors’ appetite for companies with significant growth potential.

Contributing to the current fervor: Investors are feeling more optimistic, with the Dow Jones industrial average and Standard & Poor’s 500 indexes rising to record highs.

With interest rates low and big companies not growing much, investors are more willing to take risks in the hunt for bigger returns. A federal law enacted last year that will allow start-ups to raise money from smaller investors could send tech valuations even higher.

Investors’ target: social media. With the success of Facebook, LinkedIn Corp. and now Twitter, the sector has proved it is not a passing fad.

But not every social media company that has clinched a multibillion-dollar valuation will prosper, Damodaran said.

“It’s like the guy who sells the Brooklyn Bridge to eight people when he doesn’t own the bridge,” Damodaran said. “They can’t all be winners.”

The decision to turn down billions of dollars drove people to rant on social media after the Wall Street Journal first reported the Snapchat news. Tweeted novelist Kurt Andersen: “I’ll bet anyone $3 that Snapchat is worth less than $3 billion 3 years from now.”

Snapchat captured the fancy of young people with a self-destruct feature that makes messages, called “snaps,” disappear seconds after they are viewed.

Eight months ago, investors handed Snapchat about $13 million and estimated its paper worth at $70 million.

Last month, Kara Swisher of technology blog All Things D reported that Snapchat might raise $200 million at a valuation of $4 billion. Evan Spiegel, 23, and Bobby Murphy, 25, former Stanford fraternity brothers, say their start-up is worth billions more.

Having previously nixed a $1 billion offer from Facebook, Snapchat belongs to an exclusive club of white-hot start-ups that have rejected huge offers in high-stakes gambles, hoping to become multibillion-dollar companies in their own right.

Many of those bets haven’t paid off. Take daily deals service Groupon Inc., which foundered after rejecting Google’s nearly $6 billion bid in 2010 before its IPO, or social media pioneer Digg, which once fetched a heady valuation of more than $160 million, only to sell for about $500,000 last year.

Facebook is one of the lucky companies to come out on top. It turned down a $1 billion buyout offer from Yahoo Inc. and one for $15 billion from Microsoft Corp. Today it has a market cap of $120 billion.

But for every Facebook, there are plenty of Myspaces.

© 2014 Star Tribune