As reported by Reuters, the so-called congressional “Super Committee” failed to reach a deal on reducing the federal government’s deficits today. Following similar events at the end of July, when the American government came close to defaulting on part of its debt due to a deadlock in negotiations over a new debt ceiling, the US credit rating was downgraded by S&P from AAA to AA+ on August 5th and markets all over the world took a plunge.

Today international stock markets closed down already, probably because the bad news from the Congressional Budget Office have been anticipated. This won’t stop markets from also opening down tomorrow, however.

As Greek unions continue their 48-hour general strike before the vote by lawmakers on the proposed five-year austerity plan on Wednesday, markets have been slightly optimistic today. Given that European stock indices are up today (with banking stocks particularly strong), Greek 10yr bond yields are at a three-week low and CDS spreads have tightened, it looks as if the market is quietly betting on Greece’s Prime Minister George Papandreou to gain lawmakers’ support in tomorrow’s vote. The decision on whether or not to pass Papandreou’s €28bn austerity measures is a crucial one that will likely have a significant impact on the financial markets, considering that a failure to pass the plan could result in the euro area’s first sovereign default. After all, Greece will only receive the fifth €12bn installment of the €110bn bailout from the EU and the IMF if its parliament will vote in favor of Papandreou’s plan. The tranche will ensure that Greece will be able to pay creditors through mid July. After that, the country will be dependent on a new EU/IMF bailout package believed to be worth €120bn that, too, is conditional on the passage of the austerity program and the laws needed for its implementation.

Meanwhile, European banks are discussing ways of contributing to this second rescue package for Greece. French institutions announced they would be willing to roll over 70% of their Greek debt maturing between 2011 and 2014. Apparently, 50% of the proceeds from those bonds would be reinvested in new 30-year bonds with the remaining 20% to be invested in zero-coupon AAA bonds with deferred interest. It is possible that the new bonds will be placed in a special purpose vehicle (SPV) backed by the European Financial Stability Facility (EFSF) so they won’t show up in the banks’ balance sheets anymore. According to Deutsche Bank’s Josef Ackermann, German banks are looking into the French model as well as other possiblities, too. Although it was Germany’s Angela Merkel who first proposed a private sector participation, again it is Nicolas Sarkozy who seems to be getting things done. Mrs Merkel continues to appear indecisive when it comes to actually closing deals instead of merely coming up with possible strategies. Anyway, France has a special interest in Greece not defaulting on its debt, because French banks have the biggest exposure to Greek debt with €65bn in liabilities. Next in line is Greece itself with around €59bn, followed by Germany (€40bn) and the UK (€19bn). The ECB remains the largest single creditor with €49bn worth of Greek bonds on its balance sheet.

The private sector’s search for a good strategy for helping with the rescue of Greece is also made difficult by the fact that rating agencies could classify such an undertaking as a default event, depending on how it were to be executed. Fitch already said it was likely that the company would cut Greece to default if the EU were to go through with its plan to have private investors roll over their Greek debt. In any case, it is very important that the Greek parliament will back its Prime Minister on Wednesday. This will send positive signals to investors worldwide. I am not sure anymore whether Greece can be saved from defaulting, though. It is important for the EU to have a strategy in place for such a scenario. An orderly default of Greece might be unavoidable in the long run if the EU’s other member states do not want to throw ever more good money after bad.

Technology companies like LinkedIn, Pandora, Groupon and Facebook are being valued at mind-boggling revenue multiples. In the face of relatively meager earnings, the fast-growing niche of social networking looks severely overvalued, bringing back memories of the last decade’s dot com bubble.

Over the past couple of weeks one must increasingly have been under the impression that technology history may be about to repeat itself. Again, technology companies, many of which are still in their start-up stages, are being valued at mind-boggling revenue multiples that the respective companies and venture capitalists are trying to justify by pointing to web statistics such as page views, unique visitors, registered users or even entirely new metrics they invented themselves (“income before expenses”, as they are often called). Groupon, for instance, introduced a metric called “adjusted consolidated segment operating income” (short: Acsoi). Supposedly, Acsoi is the firm’s operating profit minus its marketing and acquisition expenses. Under US accounting standards, Groupon shows a loss of more than $400m, using Acsoi this magically turns into a $61m profit.

What do these income-before-expense-metrics tell about the companies’ financial situations and outlooks? This is a rhetorical question, of course, with the answer becoming evident when looking at technology stocks in the early 2000s. What they are supposed to cover up, is that most of the new web start-ups are severely overvalued not only in terms of the 2010 revenue multiples, but also based on multiples derived from current 2011 revenue outlooks. Is it the year 2000 all over again?

Almost. This time it is not the entire technology sector that is overvalued, but it is the relatively narrow niche of social networking firms. The shares of professional networking site LinkedIn, for example, jumped more than 150% to $122.7 on the day of its IPO on May 19, 2011, only to fall back to $67.92 as of this writing. LinkedIn reported a profit of $3.4m last year, mostly from advertising and membership fees. This is a tiny profit, considering the firm’s current market capitalization of $6.4bn. Pandora, an online radio site which is valued at $4bn despite revenues of little over $100m last year, benefited from LinkedIn’s IPO too. But under its current licensing terms, the more songs users listen to, the more Pandora ends up paying in royalty fees. This deal alone lacks entrepreneurial brains, in my opinion.

Granted, social networking firms are growing fast. But as long as web 2.0 companies are not able to translate their extreme popularity and growth into sustainable profits, I prefer to remain sceptic. Advertising alone cannot be the answer to this problem. With the increased use of ad blockers and general “ad blindness” by today’s internet users, relying almost exclusively on paid ads will turn out to be a dangerous business model. Even Google has realized this by now and is beginning to branch out into new markets such as cloud computing, operating systems and telecommunications.

Unfortunately, it is not just the absence of robust business models that should caution potential investors. The aforementioned creativity in terms of financial accounting and reporting is just as big a problem. As an investor, I choose not to trust a company that is desperately trying to cover up losses and turn them into profits using non-standard accounting rules.

Recommended reading:
- Accidental Billionaires: Facebook (Paperback) | (Kindle Edition)
- The Google Story (Paperback) | (Kindle eBook)
- Wikinomics (Paperback) | (Kindle eBook)