Friday, May 27, 2011

Is There A Social Networking Business Bubble Forming?

What to make of the uproar over LinkedIn's IPO valuation? I haven't kept abreast of all the details, but I'm aware that the value of the IPO soared, then fell.

The nearby chart displays the first few days of the firm's equity prices. Suffice to say, overall, lucky buyers of the issue have enjoyed a handsome return in just the first five days.

Of course, there are all manner of opinions on LinkedIn's prospects.

For example, some co-anchors on Bloomberg did the math and contended that the newly-public firm would need to grow at a rate of some 50% per year for the next two years to justify its price/sales ratio.

Others have noted how slim the actual base of publicly-offered shares is, how dilutitive employees' options will be, and how much volume could be dumped by underwriters at the first chance to do so.

Regardless, the feeding frenzy by other social networking-based companies is now afoot. Zynga has plans to go public in June. Margaret Brennan of Bloomberg quizzed an analyst about how serious one should take Zynga's revenues, where real money is spent to buy cyber items in virtual worlds.

Point taken.

Take a big step back and ask yourself, just what is the nature of these firms? What are they selling, and how competitively defensible is it?

LinkedIn sells recruiters and HR people access to business professionals. I believe there is some other membership upgrade, as well as the ubiquitous online advertising play. So LinkedIn actually has something to sell, but as for how much growth there is, well, it's not exactly Facebook.

Zynga seems to be mostly an online gaming site. It's unclear how much long term value that site really has. Thus, I suppose, the great dispatch with which the founder is planning an IPO.

One of the social networking site founder wunderkinds was on one of the business cable channels expounding on how all sites wishing to gain or retain allure need to add a group or social aspect to their offerings. That is precisely the sort of sentiment that got the original internet-based technology bubble off to its start.

Recall, if you will, that suddenly clicks outshone bricks, and online companies marketing everything from business supplies to pet items soared.

Let's assume their is some value in social networking aspects of some online behavior. How much of it is truly defensible from a business sense? As I wrote in this post concerning Groupon, the barriers to entry in some of these product/markets  are much lower than you might initially believe.

A while later, I wrote this post reinforcing my earlier impressions,

"Groupon and its ilk just aren't businesses which I see as capable of delivering long term consistently superior shareholder returns, when they are public. There seem too few barriers to entry, too little in the way of proprietary, defensible competitive advantages, and an evolving sense by many customers, i.e., retail merchants, that what these services provide is, in the end, not really all that different than conventional couponing, and not necessarily loyal, full-price customers, either."

I've yet to actually see a firm which has begun with a social networking application, other than Facebook, a first-mover, which doesn't seem to be fairly defenseless and vunerable. On the other hand, it's much easier for an Amazon or Apple to add social networking, links to Facebook, or what have you, to their existing, robust business model. In that sense, my equity strategy process is thus already in a position to own social networking assets with relatively lower risk than chasing after Zynga or LinkedIn.

It's hard not to see a bubble forming in this online social networking space. The fundamentals are pretty much in place- hot user acceptance, more eager retail investors than companies and shares to buy, and a still-recovering IPO market.

But, investment bubbles being what they are, we'll probably be observing this one in hindsight sometime next year, or the year after.

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