Can We Avoid Another Internet Bubble?

Launching the Om Says daily newsletter, our fearless leader noted that Silicon Valley is full of confusion right now. There’s so much information being thrown at us all that we lose the ability to understand the bigger picture or, in his words, “a whole lot of activity is distracting us, masking what is really happening when viewed from a larger landscape.”

That comment turned my mind to a handful of reports over recent weeks that I’ve been thinking about closely. Amid the torrent of news we see each day, they caught my attention not necessarily because of what was said — but because of how, when and where it was said.

First there were Twitter’s “low-level” acquisition talks, which valued the messaging service at $10 billion, then there was JP Morgan Chase considering a $500 million new media fund, and just the other day came Zynga’s hopes to raise another $250 million, with a $7 billion valuation.

All three stories have some things in common. First, they all send the same underlying message: “There is money to be made by investing in Silicon Valley companies!” Second, they all appeared in the Wall Street Journal (s nws), the newspaper of record for investors, bankers and venture capitalists. Lastly, they’re all speculative.

I don’t mean speculative as in untrue, but speculative in the sense that they reflect something that hasn’t happened yet and might not ever happen. Twitter’s value is based on a hypothetical buy-out (and CEO Dick Costolo apparently says “it’s just a rumor”); Zynga is hoping to secure a $7 billion valuation; and the JP Morgan new media fund is not yet concrete and is not yet investing. These are stories about aspirations.

In this I’m not saying that the Wall Street Journal is reporting anything that’s not actually happening; I’m sure each of these stories is a faithful report of activity that is going on. But stories can make news happen as well, encouraging those who read it to act. Leaking rumored acquisition talks is a time-honored practice for getting another buyer to step up or goad an executive into faster action. What’s crucial to consider is the reason these stories appear when they do and where they do. Executives, investors, acquirers, competitors: Almost everyone who might be involved in getting these stories to the public has some sort of vested interest in seeing particular information either leaked or suppressed.

That’s fine to insiders, who know enough to dismiss a rumor as chatter, or already have the inside track on another deal that’s in the works. But for the vast amount of people who take the information at face value — the sort of people who might chat about this stuff in the office and use it, even in the tiniest way, to inform their thinking — it’s impossible to understand what the motivations are behind each individual rumor.

At the same time, people often assume that the industry has an interest in stopping the bubble from inflating, that nobody wants to return to the bad times of the dotcom crash. Because nobody wants be the guy who buys another Bebo, or oversees a sour marriage like AOL Time Warner (s aol) (s twx), or cuts thousands of jobs and throws in the towel, right?

Well, of course nobody wants that to happen … to them. The truth is, most people think they are smart enough to cash out in time and avoid the worst excesses of the bubble. Except, of course, not everyone can be the smartest person in the room. That sort of thinking is exactly the thing that helps bubbles inflate — and when you combine it all with the other pieces of the puzzle we see — such as Facebook’s $50 billion valuation and loss-making Pandora’s IPO — you’re rapidly assembling all the ingredients for this cycle to blow up.

We may be heading into another bubble. It’s possible we’re already inside it. The news we see each day suggests all the right elements are in place: companies valued much higher than their profits would suggest and old world investors looking to pump money into a growing market for easy returns. And as we start to talk more about a new raft of stock market flotations, the bubble will move from professional investors towards the public market — where it can have really disastrous consequences.

But it doesn’t have to happen. Bubbles are not inevitable. So when you see information about valuations, investments and rumored deals, then remain skeptical: Why is this here? Who gains from this? What else is going on?

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