Market Crash = End of Web 2.0?

Probably not, but it’s worth considering. 

Using cyclically adjusted valuation measures (those that take into account today’s record-high profit margins), the U.S. stock market has been overvalued for years.  The Internet sector is not particularly stretched, especially not relative to the multiples of the late 90s, but if the entire market goes into the tank, the ‘Net stocks will go with it.  Any number of factors could end the party–housing, flattening corporate profits, recession, China recession, etc.  Whether the market will actually tank is anyone’s guess, but it could drop another 30% and still not be "cheap" using cyclically adjusted measures.

For the past few years, meanwhile, Internet entrepreneurs have become ever more brazen about not needing a business model in order to cash out big (and who can blame them, given the bounteous rewards that have gone to Google, MySpace, YouTube, and dozens of other companies that postponed revenue for as long as possible–not to mention the vast amounts of venture capital that keep pouring into the sector?).  This is reminiscent of the late 90s, when all that was needed (apparently) was a business plan. 

In the late 90s, of course, the early stages of the market crash revealed that much of the Internet economy was dependent on public-market leverage (10 companies a week going public, raising $100 million each, and spending it on advertising, software, real-estate, accounting services, etc.).  When the IPO market dried up, so did the Internet sector.  Today, the situation is different–today’s start-ups aren’t usually "exiting" via the public markets but by acquisition, and a fraction of the number of companies are competing to win the entrepreneurial lottery.  But a crumbling of the public market would still have a significant impact on the industry. 

Reduced market caps and multiples would mean lower acquisition prices and, likely, a more cautious approach to risk-taking (no more $4B eBay-Skype fliers, for example).  This, in turn, would mean more caution on the part of the angels and VCs who are funding the revenue-less prosperity of many Web 2.0 companies.  And a slowdown in the economy (either as a result of or as a cause of the market decline) would mean that revenue of all types would be harder to come by.  So, just when they needed it the most, many emerging companies might find that the AdWords bounty they had always kept tucked in their back pockets might amount to less than they had once imagined.

A disaster scenario?  Not likely.  But a scenario that would lead to another cold winter for the Internet start-up ecosystem?  Very possible.  Possible enough, certainly, that conservative Netrepreneurs (and their backers) might want to hit the summer-time bids while they still can.

http://www.internetoutsider.com/