Pre-IPO Startups Join the List of Bubble Sectors

Companies like SnapChat, Dropbox and Pinterest are fetching huge valuations

   

With the frothy valuations of Twitter (TWTR), LinkedIn (LNKD) and Facebook (FB), the talk of a bubble has been inevitable. But it’s not just public tech operators that are fetching inflated market caps — startup companies are getting in on the action. And it could mean that “savvy” venture capitalists may be setting themselves up for lots of pain.

To get a sense of the environment, just take a look at popular file-sharing service Dropbox. Based on various reports, the five-year-old startup is seeking a round of $250 million in financing at a valuation of about $8 billion. The company has already raised $312 million.

There’s no doubt that Dropbox provides a great service, as demonstrated by its user base of 200 million.

But according Quartz’s Christopher Mims: “…Dropbox has a problem: Some very big competitors want its business. And they are willing to offer absolutely anyone even more free cloud storage space than Dropbox to lure them away.” He points out that the service provides only 2 gigabytes of free storage, while Google (GOOG) offers 15 gigabytes and Microsoft (MSFT) allows about 7 gigabytes. These services are also easy to set up and could entirely replace Dropbox.

Perhaps this intense competitive environment is taking a toll on the growth rate for Dropbox. According to the Wall Street journal, while revenues more than doubled in 2012 to $116 milion, they are only expected to reach $200 million this year.

So to find new revenues sources, Dropbox has been building out its enterprise offerings. However, companies like Box have a head-start in this market. Besides, it is far from easy to nab large customers, which often requires the wooing of a direct salesforce.

And Dropbox isn’t the only tech startup raising huge rounds at outsized valuations. Online scrapbooking service Pinterest recently nabbed $225 million at a $3.8 billion valuation. The company’s revenues are minimal,  but major brands like Williams-Sonoma (WSM), Lowe’s (LOW), Sephora and Sony (SNE) have been using the platform to find new customers.

Oh, and then there was Facebook’s $3 billion buyout offer for SnapChat, a messaging service that allows people to share secure photos and videos which delete within a few seconds. The service has become hugely popular with teens, but so far, revenues are non-existant.

These investments could turn out to be grand-slam homeruns. But if history is any indication, there will also probably be some big-time flameouts. Remember Friendster or MySpace or Digg? They all attracted big rounds of funding, yet suddenly disappeared … all to be replaced from the latest cool whizbang service.

In fact, there are some signs of this already, as seen with problems at Fab.com, Path and Foursquare. Despite grabbing substantial sums from VCs, it looks their businesses are far from hot.

The tech space is fraught with dynamic changes and disruptive shifts, which means the next few years may be brutal for VCs.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO StrategiesAll About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/ipo-playbook/theres-bubble-pre-ipo-startups/.

©2014 InvestorPlace Media, LLC

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