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Silicon Valley web giants face 10-year tech exit

Why Google, Facebook and Twitter are risky bets

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Open ... And Shut Silicon Valley companies continue to get outsized valuations, cast as high-growth tech companies. But while Twitter, Facebook, Google, Groupon, and other so-called tech bellwethers continue to grow, it's increasingly difficult to tell them apart from their kissing cousins in the media, advertising, and retail businesses.

Do they still deserve outsized price-to-earnings (P/E) ratios their California locations grant them?

Facebook's Mike Shaver, formerly Mozilla's vice president of engineering, called this to my attention when challenging my description of Twitter as a "web business."

It's a fair point. The article I had referenced, after all, called out Twitter as a growing advertising dynamo, built on a steady stream of real-time information and news. Twitter uses technology, in other words, but its business isn't technology.

The same is true of Google, Facebook, and Groupon. Google calls itself a web property and talks up the value of its search technologies, but both it and others bill it as the world's largest ad network. Facebook has a ravenous appetite for recruiting engineers, but describes itself as a "social utility that connects people with friends and others who work, study and live around them."

And Groupon? Well, it's arguably a very low-tech coupon-cutting service. But don't tell that to the bankers or Groupon executives who pitched the company as a tech powerhouse as part of Groupon's IPO roadshow. That's cheeky when you consider that 47 per cent of its employee base is made up of sales heads, and a paltry five per cent is dedicated to engineering.

Which isn't to say that these companies are not great companies (though the jury is definitely out on Groupon, in particular). Rather, it's just to suggest that their heavy reliance on technology doesn't make them different.

In fact, it just makes them like every other company, albeit ahead of the curve.

Novelist William Gibson famously declared that "The future is already here – it's just not evenly distributed." That seems particularly true of technology. We attach eye-popping P/E multiples to Google, Facebook, Twitter, and friends because we believe they represent huge growth opportunities, and will be the foundation for new industries or new ways to capture value in existing industries.

Such thinking may be suspect for at least two reasons.

The first is that many are aggressively using technology today to drive their businesses, but their peers outside the Valley are working hard to catch up. WPP Group is the world's largest advertising agency, and so arguably a competitor to Google's advertising business. But WPP gets a comparatively paltry P/E multiple of 14.25, despite spending heavily on technology.

Over time, WPP Group has introduced technology that sounds quite Googlesque, including Xaxis, which links ad-buying technologies with a massive database of consumer profiles. And, perhaps not surprisingly, over time Google's P/E multiple has settled into WPP's range: in 2006, Google's P/E ratio was 77. In 2005 it was over 125. It's now hovering around 20.

In fact, if you track Google's P/E multiple since its public debut, it's clear that it is increasingly treated as a slower-growth advertising company, and less like a tech high-flier. Competitors like WPP, in turn, will be granted a bit of the tech valuation pixie dust as they invest in tech to accelerate their businesses. Google and its wannabes will meet somewhere in the middle on P/E.

Which brings us to the second reason to discount "tech" valuations: the principle of "creative destruction" makes it likely that few so-called tech companies will live long enough to justify their valuations.

As John Talbott points out, the sky-high P/E ratios with that we bestow upon Silicon Valley companies suggest we believe these companies are not only going to grow in the short term, but will be around for a long, long time. It's not enough to believe that Google, for example, is the future of advertising. We also have to believe that it will play a long-term role in that future, growing 20 per cent each year for the next 40 years, paying dividends along the way. Facebook, at current valuations? It needs to stick around 54 years.

Given the rate at which the "tech" industry chews up and spits out its stars, these may be very bad bets, indeed.

Coming back to Shaver's question, I suspect that many, and probably most, of the companies we currently classify as "tech" won't be thought of as such in 10 years, much less in five. We are living through a time when technology is still magic, but that won't last. Or, rather, its uneven distribution won't last, not to the extent of today. We don't call Wal-Mart a tech company, despite its aggressive use of technology, and soon I doubt we'll think of Google and the rest as tech companies, either.

Will Silicon Valley valuations plunge to reflect the reality of how Wall Street values "normal" companies? Probably. But that's because we will have helped the world become extraordinary. Of course, Silicon Valley will also likely have moved on to the next big thing.

After all, as Shaver has also suggested via Twitter: "Yes, the bar will go up for 'enough tech to not lose', but [it's] still different from 'we compete primarily on [the] basis of tech excellence.'" He may be right. I find it hard to believe that Silicon Valley will ever look like a carbon copy of the technology vision of anywhere and everywhere else.

Which is why we'll likely be selling our pet food at brick-and-mortar stores just when the world has moved to selling it online. We're disruptive like that. ®

Matt Asay is senior vice president of business development at Nodeable, offering systems management for managing and analyzing cloud-based data. He was formerly SVP of biz dev at HTML5 start-up Strobe and chief operating officer of Ubuntu commercial operation Canonical. With more than a decade spent in open source, Asay served as Alfresco's general manager for the Americas and vice president of business development, and he helped put Novell on its open source track. Asay is an emeritus board member of the Open Source Initiative (OSI). His column, Open...and Shut, appears three times a week on The Register.

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