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There has recently been a buzz around investing in social media stocks, following a spate of highly subscribed initial public offerings (IPOs) in the sector. The success of the professional networking website LinkedIn's IPO was dazzling, and the company currently enjoys a market capitalisation of 6.8bn dollars; the deals website Groupon has a market capitalisation of 12.2bn dollars following its recent IPO, while games developer Zynga and Chinese social networking website RenRen are estimated at 6.2bn and 1.53bn dollars respectively. The hotly anticipated IPO of Facebook, the world's largest social networking site, has seen analysts punting its market value at a whopping 100bn dollars, which would make Facebook one of the world's largest companies, surpassing McDonalds and Disney. The microblogging website Twitter is thought to be worth as much as 10bn dollars. Are these stellar valuations justified for such a young sector?
[inset_left]It could be that investors have forgotten the lessons of the dotcom bubble.[/inset_left]Most of these companies have a price to earnings ratio (p:e) exceeding 20, which is appropriate for growth stocks. To put the investment risk in perspective, Google is seen as a sensible yet innovative technology stock, is worth around 202.4bn dollars, and trades at a palatable p:e of about 21.3. Then consider LinkedIn. At the time of writing, LinkedIn stock is trading on a p:e ratio of about 1,388.50. Already vulnerable to short-selling, LinkedIn’s stock could be regarded as heavily, even dangerously, overweight, as investment guru Warren Buffet has cautioned. Either the market sees limitless potential in LinkedIn's future growth, or these are signs of another major internet stock bubble.
Social media, or Web 2.0, falls into the media and technology sector. As sectors go, media stocks are normally cyclical and particularly vulnerable to economic recession, and technology stocks can be tricky to evaluate because they reflect consumer trends and fast-changing innovations of normally non-essential products and services. Sometimes the market's readiness lags analysts' forecasts for the company. Also, social media's success is particularly dependent on perceptions and trends of youth markets, and so it is highly sensitive to where users think are the coolest places to hang out on the web.
Google is said to have lost intolerable amounts of money with its acquisition of YouTube, and everybody's favourite media baron Rupert Murdoch recently admitted (by tweet) that his behemoth NewsCorp. learnt an expensive lesson (some analysts say in the region of 1bn dollars) in its loss-making acquisition of MySpace. The Global X Social Media ETF (exchange traded fund, a basket of representative stocks) has seen its value steadily decline over the past year (see picture). It could be that investors have forgotten the lessons of the dotcom bubble. On the other hand, it might also be that the performance of the Global X Social Media ETF, which includes several of the lesser known social media companies, indicates the sector is being crowded by pretenders punching above their weight, and looking for a free ride off the success of big-name brands like Facebook, LinkedIn and Twitter. Many companies failed during the dotcom bust a decade ago, but some impressive web-based companies survived and became internet stalwarts. Amazon and Google are examples.
Social media websites undoubtedly have solid business appeal. They can improve product awareness and increase sales, facilitate and maintain contact across international borders, and their capacity to share information at near instantaneous speeds is unrivalled in human history. But they struggle to keep up-to-date with the changing tastes of web users, or make profits beyond advertising and marketing.
It might be that Murdoch's social media consultants were not savvy enough to recognise the fickleness of this market, or to appreciate that MySpace had largely cannibalised the mostly teen users of social networking website Bebo. Similarly, Google is trying to gobble up market-share from Facebook with its GooglePlus social networking platform, although so far it has not gained traction.
Have social media stocks market peaked even before they have had their day in the sun? Or were some of these developments premature? Web 2.0 is only now becoming an indispensable part of everyday life and some analysts think there is still plenty of room for growth, particularly in emerging markets where computers and mobile telephony are still being rolled out with great success. In developed markets, online gaming, instant messaging and other variations of Web 2.0 are increasingly popular with the lucrative teens' and tweens' markets. Sounding a cautious note, social media consultant Colin Gilchrist says, “There is absolutely more room for growth, but not much. I do foresee some barriers going up, especially across continents, and people networking in silos.” Most of Facebook's users are in Europe and North America, forecasts for Chinese social media stocks are uneven, and Twitter’s market growth is rapidly increasing in the Middle East and North Africa. Using some form of social media might become something as commonplace and necessary as owning a mobile phone or having access to email. Indeed, as social media websites increasingly incorporate telephony and email, it might become impossible to avoid them. There are therefore many optimists about social media, one of them being Prince Alwaleed bin Talal, who recently acquired a 300m dollar stake in Twitter.
Despite reservations from analysts about overweight valuations, strong brands like Twitter and Facebook might indicate that social media's zenith is still coming, and not least because of the untapped potential of markets in Africa, Asia, and the Middle East. While optimistic about the latent potential of social media, Gilchrist thinks valuations need to come down, and worries about the impact of big money chasing these organic platforms. The monetisation of social media platforms is a complicated issue. Online content and services providers feel they should be remunerated for their innovations, which also provide enormous value to our everyday lives. Similarly, the benefit to advertisers is obvious. However, social media websites are distinguished from other websites because their content is user-generated; charge users and they will migrate to other social media. This is a critical aspect to the capitalisation of social media: they require a business model that recognises that people are their products and not their consumers.
Social media valuations will remain a dark art until the staying power of reputable and useful brands is established. For now, LinkedIn is the stock to watch to get a real sense of what this market will do next.
