The Middle East, North Africa and the Ferengi Rules of Acquisition #s 34 and 35

War is good for business.  Peace is good for business.  At least according to two of the Two Hundred Eighty-Five Rules of Acquisition that compose the sacred code on which all of Ferengi society is based.  You just have to love the writers of Star Trek sometimes! 

Last evening, I listened to President Obama tell the nation why America is participating in enforcing a no-fly zone over Libya.  Skeptics on the left and the right will assuredly be pissed off by this recent decision of the executive branch.  The left will abhor any military engagement and the right will hate any Obama Administration action.  I think the President probably waited too long to do what we are doing now (we should have stepped in to assist a couple of weeks ago and not let Qaddafi’s forces gain any upper hand), but ultimately the Administration decided to back the same forces of change in both Tunisia and Egypt that have sandwiched Libya.  Very few in the broader Arab world can complain about preventing a potential slaughter of civilians in Benghazi and fewer still will shed many tears at Colonel Qaddafi’s departure. 

It would be nicer and more convenient if the United States held a coherent, regional strategy.  But consistency is the hobgoblin of small minds.  America is now interested and involved and is doing the right thing alongside the political cover of the UN.  We are the chicken and not the pig in bacon and eggs in this situation.  The Obama Administration appears inherently conservative (I am shocked I am using “conservative” in the same sentence as Obama Administration, but yes, it appears to be so in this case) on many foreign policy issues so this slight delay and ultimate handover of control to NATO should not come as a surprise to Washington watchers.

Ultimately, if a war does not drag on for years on end and if there is a peace that follows and Libya does not evolve into Iraq, this situation is good for business.  I do not think Libya is Iraq.  The Libyan people back the intervention and the insurrection is part of a broader trend.  There is an arc in northern Africa extending from Tunisia to Egypt of well over 100 million people who will ultimately have the opportunity to have some sort of self-government.  Although a peaceful transition to a democratic society where millions of people will finally have the opportunity to enjoy the fruits of their labors and enter the middle class is by no means assured, I believe the chances are far better today than they were one week ago. 

In the meantime, someone will benefit from rebuilding after the bombing raids.  Someone will make money from the explosion and flowering of new commercial efforts that will burst force and erupt once the shackles of the Qaddafi regime are thrown off.  As the Ferengi have noted, “War is good for business.”  Perhaps they should have said “Peace is even better.”

Plus ça change....

In May 1999, basically a lifetime ago, I made a presentation entitled “Valuations in La-La Land” for Burt Alimansky at what was then called the New York Venture Group, now subsequently renamed the New York Capital Roundtable.  I came out on record against silly valuations 10 months prior to the NASDAQ high before the Internet bubble crashed.  I am probably at least 10 months ahead of the high again for this new Internet bubble as well. Indeed, I never thought I would see another bubble this soon.  Fortunately, it is not of the same magnitude and does not involve nearly as many companies since it is primarily limited to those enterprises related to the social networking and software as a service (SaaS) arenas.  Still, for selfish reasons I love that Cornerstone OnDemand IPO!

Why do I think there is a bubble forming again?  What are the signs that I see that are similar to what I noted in 1999?  Do I find myself listening to Prince’s ”1999” a lot more often these days?  Well, yes, but that’s only for nostalgia purposes and has nothing to do with any Internet related bubbles. 

Facebook, Twitter and Groupon may indeed have very good business models, but they are in no way worth the tremendous valuations that they are commanding today just as many of the Internet darlings of the late 1990s with good businesses were in no way worth the valuations that they were commanding at that time.  Almost all of the high flying companies of the late 1990s have never recovered their pre-crash highs, but some (Amazon and Ebay to name a few) have been able to re-achieve and even surpass their former glory with a lot of hard work.  These solid companies represent the great exception and not the general rule, however, and even excellent enterprises such as Cisco remain far below their former glory. 

There are a host of factors at work driving the valuation inflation this time around.  Once again, too many dollars are chasing too few deals.  But this time, it is not because too much money has been raised by venture capital funds and it simply has to find some place to be put to work.  This time, I believe much of the money is heading into a few big companies that have serious scale and momentum.  The valuation of several of these good, large companies is simply far too high and is driven often by less sophisticated investors participating in the secondary markets handled by SharesPost and SecondMarket.  And as in the late 1990s but on a smaller scale, lesser companies are getting funded (often by angel groups) with valuations keyed off of these inflated valuations.  A rising tide lifts all boats.  Beware when the tide goes out….

Facebook is a solid company, but it is not worth $50 or $75 billion today.  In order to double investors’ money, the company would need to become worth $100 or $150 billion.  There are fewer than 10 US technology companies worth that amount of money.  Even Ebay and Amazon are not among the number worth over $100 billion today!

“It’s different this time.”  Mashable co-editor Ben Parr told Silicon Republic that this investment phase is different from the bubble of the 1990s, because Facebook, Groupon, Zynga and others have viable business models and are making money.  Members of the public also are more willing to use Internet services than they were before.

“Do I think there will be a day of reckoning? No, I don’t.  Will there be a time where some of these valuations will go down?  Probably, there’s always a cyclical cycle when you talk about markets,” Parr told Silicon Republic.

But it is never, never different this time.  That is the lesson that history teaches us.  The valuations are elevated and they will inevitably come down hard.  The only open question in my opinion is when the bubble pops.  The exact answer is beyond my pay grade, but I would posit 9 to 18 months.  The day of reckoning hits when the companies that need to raise money go out for the next round of capital and get pounded or when the big companies try to raise capital in the public markets and find that institutional money managers are not willing to pay the same high prices in the public aftermarket that private investors are paying in the private secondary markets. 

The fallout will not be as great this time the bubble bursts.   Fewer firms and fewer individuals are involved with this Internet bubble, which will probably be referred to as Bubble 2.0 or something equally clever.  In addition, there will probably be hand wringing about “unregulated” private secondary markets and “asymmetric information” and calls for “government investigations” into Goldman Sachs Investment Partnerships and “new regulations” as well.  There will probably be a Congressional hearing or two, but not much will change.  Plus ça change….   

The Big, Big Trends

I have written that US schools are hemorrhaging money, Canada is looking relatively good when compared to America, and the FDA is regulating us to death, but all of these concerns (as important as they are) fall short when compared to some of the really big trends facing the world today.  One of them is the subject of this post.  There is a tremendous transformation going on across the globe right now and it presents perhaps the greatest opportunity of my lifetime – even greater than the rise of web technologies over the past two decades.  In fact, web technologies and mobile smartphones are going to help drive this transformation.

At least two billion people will become middle class consumers across more than a dozen emerging nations according to McKinsey Quarterly.   These consumers spend $6.9 trillion today and will spend over $20 trillion by the end of the decade – more than the GDP of the United States today and far more on a purchasing power parity basis!  These are simply staggering, almost incomprehensible figures.  Think about it -- $20,000,000,000,000.  You almost have to use scientific notation for numbers this large. 

These consumers live in countries where the median age is about 25 years old  (give or take).  Much of non-Japan and China Asia and Latin America fall into this category.  These new middle class consumers have very little debt.  For example, Brazil’s household debt is only about 2.2% of its GDP whereas household debt is about 100% of GDP in the US.  Guess which households are keeping their fingers crossed for low interest rates?  Emerging market youth live with their parents well into their 20s.  They save on rent and therefore have plenty of disposable income today.  They own iPhones.  They go to clubs at night.  These consumers are connected to the world wirelessly and are thrilled by the chance to learn about the plethora of options to buy, to see, and to experience new products and services.  The opportunities lie in providing these new consumers and their parents with the consumer goods and services they now have the money to buy.

In the next few years, consumption patterns across the globe will shift dramatically.  Once consumers have some money in their pockets and in the bank, they consume more than just shelter, basic food and clothing items.  They discover they want “housing,” and often “meat” and “apparel.”   With adroit marketing, these consumers can find out about all sorts of new needs.  And beyond the aforementioned basics, new entrants to the global middle class find they desire branded personal care products, transportation such as a motorbike or auto, entertainment, travel and leisure opportunities like gaming, healthcare and education.

Satisfying the changing consumption habits of the emerging global middle class represents the greatest single opportunity of the next 20 years.  Time to sign up focus groups in Hanoi and Rio de Janeiro.  Let the education process begin....    

Inflation versus Deflation

My father-in-law and I have an ongoing debate.  Which is the greater evil facing the United States and its currency today – inflation or deflation?  My father-in-law comes down on the side of deflation; I am in the inflation camp.  Thus far, I will concede that he has won the first skirmish, but I am convinced that sometime in the next 24 to 36 months or so I am going to win the war.  Unfortunately, I believe the war will be a fairly long one, but mercifully not as long as it was in the 1970s and early 1980s.

I side with the great Milton Friedman and firmly believe that inflation is always and everywhere a monetary phenomenon.  The Treasury and its co-conspirator, the Federal Reserve, cannot create money and expand balance sheets faster than the growth of GDP without creating inflation at some point.  It is simply not possible to have a zero rate interest policy and continue along the path America is on and not face monetary repercussions down the line.  The effects are not felt immediately; our country did not spiral upward (or downward depending on your perspective) into inflation due to the tremendous expansionist policies of the late 1960s until the 1970s, but once inflation expectations took hold, our nation was only able to halt its pernicious effects through the painful medicine Paul Volker administered in the early 1980s.  We will go through this cycle again but since everything happens at a much quicker pace today, I expect the US will cycle through the process in 6 or 7 years rather than the 15 years or so it took the last time around.

There are many economists and pundits who believe that it is virtually impossible for inflation to take root in the current economy because the United States is relatively open to free trade and global competition and is currently operating at low capacity utilization (especially in manufacturing) and high unemployment.  To those economists, just point to Zimbabwe of this decade, Weimar Germany in the 1920s and early 1930s or even the US of the 1970s.    

Will inflation be as bad as it was in the 1970s?  I think the inflation scenario will play out in one of two ways – either it will not be quite as bad as the 1970s because it will not last as long or it will be much worse because it will spiral out of control and dramatically devalue the dollar.  I think the former scenario is far more likely, but the latter scenario is a distinct possibility that cannot be overlooked.  A repeat of 1970s style stagflation is unfortunately a relatively near term future that I can easily envision. 

Once again, the US mañana culture that gladly pays on Tuesday for hamburgers today, has not learned the lessons of history, has not weaned itself off of foreign oil, and oil will once again be the catalyst for the next round of inflation.  The recent turmoil in the middle east will probably only hasten the onset of inflation as food and energy prices rise and then workers will demand wage increases to cover these food and energy price increases.  Higher price expectations will then flow through the entire system.  Price pressures from imported foreign goods where inflation already exists will exacerbate the issue.  Although we have not yet witnessed much of this pernicious cycle in the United States, one can already see its nascent climb in several emerging markets – especially in Asia.

As soon as consumers believe that they can actually handle the amount of debt that they owe (they cannot quite do so today) and that they can pay off their debts with cheaper dollars tomorrow, they will stop paying down debt at the rates at which they are doing so today and the inflation cycle will begin.  Does this cycle begin in 2012, 2013 or 2014?  Well, that is a question for the big hedge funds.  The answer is beyond my pay grade.