Reload About It

Social Media is overrated. There, I said it.

In fact, Social Media is well on it’s way to becoming the next economic bubble.

And what’s remarkable is that we’re only just a decade on from the dot com burst, which saw Internet stocks wiped of close to three quarters of their total value in a matter of weeks. The lessons from this crash have seemingly been forgotten amid the mad scramble for social media stocks.

Before looking at the numbers, a quick crash course in stock valuation. Most companies (particularly those without tangible assets – like a lot of web companies) are valued based on revenues and profit margins, taking into account growth rate and the potential for future profits to continue long term. That’s an oversimplified explanation, but it’s worth keeping that in mind before looking at the actual numbers being thrown around.

The real key point is the “potential for future profits to continue” because that’s what essentially causes a bubble. Overconfidence in a stock’s future or “speculation.”

Let’s look at the facts:

LinkedIn

LinkedIn went public in May. Initially it set an asking price of $32 per share. At the time, analysts were calling this overpriced, as it valued the company at around $3 billion, a giant amount when you considered the company’s total revenues were just over $240 million (meaning profit would likely be around a third of that).

Despite this, the asking price was increased to $45 per share just days before the float (adding another billion or so to the company’s value). At this stage everyone who could work a calculator was double checking their maths.

However, what’s incredible is that on the opening day of trade, the stocks opened at $83 and soared to a high of around $120 per share by midday. At that point, the company was valued at $9.7 billion, close to $7 billion more than what it was worth before the day’s trade and a whopping 40 times its annual revenue.

Social Games

Rumours are currently circulating that social games developer Zynga (think Farmville) is currently filing for an IPO with speculation they’re aiming for a market value of between $15-$20 billion. This would make them the most valued games developer in the world, surpassing Electronic Arts (which incidently has revenues of around $4 billion) and putting their total value at the same level as Yahoo.

Again, what’s staggering is that Zynga’s revenues are estimated at $850 million (with a rumoured $400 million in profit).

Around this time last year, they were valued at $5.5 billion. So a threefold increase in less than 12 months.

On a smaller scale, PopCap games (makers of Plants v Zombies), have just been acquired (by EA Games no less) for $750 million, despite the company turning over just $100 million in revenues.

Facebook

Speculation is also mounting that Facebook, Social Media’s current champion, is also planning for an IPO worth somewhere in the vicinity of $100 billion. This is despite the company reporting revenues of around $4 billion.

Now Facebook has been growing at an incredible rate, so some might call that valuation justified. But consider that Facebook growth has slowed worldwide for two consecutive months now and total user numbers have actually dropped in the US, UK, Canada, Russia and Norway.

Facebook say they are now focussed on increasing “time on site and engagement” rather than raw user numbers but the simple fact remains that they are basically hitting the ceiling of how many people are getting onboard.

This, coupled with the new threat of Google+, makes the 25 times multiplier of revenue to company valuation seem ludicrous. Having said that, my prediction is that their actual IPO valuation will be much higher than $100 billion by the time it rolls around.

The other big consideration with Facebook is how Mark Zuckerberg will deal with the scrutiny of being a publicly listed company. Zuckerberg has already publicly said that he wants to keep his hands firmly on the steering wheel, but that raises another question. Is he going to continue as CEO?

CEOs of publicly listed companies have enormous responsibilities to shareholders and boards, not to mention all the compliance and regulatory requirements that come with it.

This was exactly the reason why Google founders Sergey Brin and Larry Page brought in Eric Schmidt to be the company’s CEO in 2001, as software engineers rarely make good CEOs.

It’s hard to see Zuckerberg making that call, which also brings into question their long-term revenue potential.

Google+

Even Google is not immune from social media speculation, with Google shares adding $20 billion to the market cap in the first week after it was announced.

Google+ has so far grabbed around 20 million users it its first few weeks following launch, and whilst the revenue potential for Google+ is apparent, it’s yet to make its first dollar.

The Warning Signs

MySpace anyone?

The once great social media site was bought by Rupert Murdoch for $580m a few short years ago, only to be sold for $35 million earlier this year.

At one point, analysts were valuing it at close to $1 billion, and it’s now at less than 4% of that. However, MySpace revenues were at $600 million at the time of that valuation, making its valuation a modest 1.7 times its revenues. Yet, despite the relatively low valuation (by 2011 social media standards), it still turned out to be about 25 times too high.

And then of course there’s the fact we’ve been through this before. In the late 90′s all a business had to do was add an ‘e-’ to the start of their name or a ‘.com’ to the end and watch the masses fight for shares.

At the peak of the boom, Yahoo shares were worth $118 a piece. Following the crash, they were worth $4.

So When Will it Happen?

If I knew that, I’d be keeping it to myself and making a fortune on stock trades.

My best guess is around two years from now. It won’t happen until after the Facebook float, and is likely to be triggered by a high profile collapse or downswing in revenues with one of the biggest players that causes a mass exodus.

We’ll have to wait and see… but don’t say I didn’t warn you.

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