Social media start-ups’ value is enormous — if you trust investors

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Snapchat founders Bobby Murphy, left, and Evan Spiegel have taken the position that their start-up is worth more than the $3 billion that Facebook offered.

Snapchat founders Bobby Murphy, left, and Evan Spiegel have taken the position that their start-up is worth more than the $3 billion that Facebook offered.

Snapchat is not even 3 years old. It’s run by a couple of twentysomethings 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 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 app 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 revenues and no profits 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 deja 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.

Their 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. It’s the same story being told over and over again. And that worries me,” Damodaran said. “They can’t all be winners.”

The hubris to turn down billions of dollars drove people to rant on social media this week 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 billions 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, invested handed Snapchat about $13 million and estimated its paper worth at about $70 million.

Courtesy of Los Angeles Times

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