It’s getting hot in here

A few weeks ago, tech billionaire Mark Cuban expressed some very strong views about the recent string of very high tech valuations – most notably the $50 billion price tag put on Facebook – when he likened the current environment to a pyramid scheme.

“It’s almost the 2011 version of a private equity chain letter,” Cuban told PEHub.

“Remember the old chain letter, where you put up some money then you got other people to put up some money and you gave it to the people who were in the deal before you? That’s what’s happening today.”

“The early (VCs) are getting the new (VCs) to invest enough money at high enough valuations that they get most if not all of their money back.”

“Then the next round (sees) someone else invest more money at a higher valuation, returning cash to the last two rounds of investors. By the time you get to the last (VC) standing, those last few rounds hope they can get a return from the public markets.

“That may be very tough. But the only players really on the hook are the guys from the last rounds. Just like in a chain letter.”

His comments were dismissed by many, but they are worth taking another look at after news this morning from “sources” that Groupon is looking at an IPO with a valuation of $25 billion.

Let’s assume for a minute that the sources have got it right. It’s an extraordinary figure for any company to list at, but it’s particularly amazing when you think that Groupon is less than two years old.

Reports suggest the site is generating $760 million in annual revenue and this is probably growing quickly, despite the army of copycats that have sprung up around the world.

But $25 billion? Even if Groupon was operating on a profit margin of 50% (unlikely given start-up costs) and could produce a profit of $500 million by the end of 2011, that still suggests a multiple of 50 times earnings. For a business that is promising, but hardly proven.

I think it’s important to remember Cuban’s comments here. An IPO isn’t always about entering a new market (the sharemarket). Mainly it’s about an exit for long-term investors.

If Groupon really gets a $25 billion IPO, they will be the real winners. And maybe the only winners.