It’s not a bubble, people; It’s a pyramid scheme

By Guest Contributor
February 17, 2011

– Connie Loizos is a contributor for PE Hub, a Thomson Reuters publication. This article originally appeared on PE Hub. The views expressed are her own. –

Mark Cuban knows a thing or two about bubbles, having profited handsomely from an earlier Internet boom. But ask him if we’re seeing Bubble 2.0 and he’ll give you a different theory.

“It’s almost the 2011 version of a private equity chain letter,” said Cuban, who sold Broadcast.com to Yahoo in 1999 for $5.7 billion and went on to buy the the NBA’s Dallas Mavericks.

“Remember the old chain letter, where you put up some money, then you got other people to put up some money, and you gave it to the people who were in the deal before you? That’s what’s happening today,” said Cuban. “The early (VCs) are getting the new (VCs) to invest enough money at high enough valuations that they get most, if not all of their money back. Then the next round (sees) someone else invest more money at a higher valuation, returning cash to the last two rounds of investors. By the time you get to the last (VC) standing, those last few rounds hope they can get a return from the public markets. That may be very tough. But the only players really on the hook are the guys from the last rounds. Just like in a chain letter.”

It’s a valid point. As certain Internet company valuations reach astronomic new heights, it’s easy to conclude that Silicon Valley has spawned another giant bubble–one that will eventually bounce its way onto the public market and soak investors. But unlike the dot.com mania of a decade ago, today’s soaring valuations don’t involve hundreds of companies and thousands of retail investors. They center on a select group of wealthy VCs chasing after a comparatively small number of very richly valued tech companies–most of which are in Silicon Valley.

Over the last three months alone, Facebook’s roughly $33 billion valuation has roughly doubled, to an estimated $60 billion. Zynga’s reported valuation has jumped to upwards of $9 billion from $4 billion last May. And both pale in comparison to Twitter, which generated an estimated $150 million in revenue in 2010 yet has reportedly received overtures that peg its worth at between $8 billion and $10 billion. (Just two months ago, when Kleiner Perkins led a $200 million investment in Twitter, its valuation was $3.7 billion.)

Fueling the fire are firms like Andreessen Horowitz, which last week sunk $80 million into secondary shares of Twitter, and Kleiner Perkins, which this week threw $38 million at Facebook shareholders to (finally) add the company to its portfolio. But they’re certainly not alone. According to the secondary shares marketplace SecondMarket, VCs have represented the majority of SecondMarket’s buyers since the third quarter of 2010 and they accounted for more than 40 percent of its transactions in the fourth quarter.

Maybe the VCs truly believe that Facebook, Twitter, Groupon and Zynga are on the cusp of becoming among the most valuable companies in the world. But it may also be true that they believe they can sell their shares to a greater fool. (JPMorgan’s planned social media fund jumps to mind.)

Either way, when the chain ultimately ends, few, including Cuban, will feel terribly sorry for those left holding empty envelopes.

“When the market has a correction, stock prices will correct dramatically, and that sound you’ll hear from the Valley?” said Cuban. “(It) will be of a fund manager screaming, ‘S***!’ as he turns out the light on his fund.”

Create your free online surveys with SurveyMonkey, the world’s leading questionnaire tool.

Photo credit: Dallas Mavericks owner Mark Cuban applauds his team, near a replica of the NBA championship trophy, at the start of Game 2 of the 2006 NBA Finals against the Miami Heat in Dallas, Texas, June 11, 2006. REUTERS/Marc Serota

2 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Take the time to study the real history of the cable communications industry. Bad network infrastructure, absurd debt, and massive insider trading to inflate share prices. Eventually, it was all paid off by a massive collapse and the gutting of companies with incredibly stupid management at AT&T, AOL, Time-Warner, et al.

Nothing new here, move on.

Posted by ARJTurgot2 | Report as abusive

People say that groupon is losing its value but i think goup on is flying high! http://grouponbot.com site is getting increasing greater no. of visitors day by day only because of their user friendly deals of all kinds especially for the discount hunters…and you can see people are cloning groupon type of sites …thats a fact but they can never provide services as good as groupon i bet on that!

Posted by Sallyj | Report as abusive

[...] It’s not a bubble, people; It’s a pyramid scheme – “It’s almost the 2011 version of a private equity chain letter…” ~ Mark Cuban talking about Facebook and Twitter This entry was posted in Morning Update and tagged DJIA, Housing, NASDAQ:AAPL, SPX, Top News. Bookmark the permalink. ← VCA Antech, Inc. Ahead of Earnings [...]

[...] It’s not a bubble, people; It’s a pyramid scheme – Mark Cuban [...]

[...] Mark Cuban calls Silicon Valley a pyramid scheme [...]