Don’t Fall for the Social Media Hype

It began with a $450 million investment in perhaps one of the most-watched companies not yet listed on a major stock exchange. When Goldman Sachs, along with $50 million from Digital Sky Technology, plunked down a cool half million-dollar bet on social networking giant Facebook, the investing world listened.

To many market watchers, Goldman’s hefty bet signaled a new market era of legitimized social media investments. However, Facebook’s success is not easily repeated. In fact, I am finding it incredibly difficult to find any significant value in most social media small-caps and perspective IPOs. These stocks can be great trade candidates, but nearly all of them lack business models that will allow them to consistently compete in cyberspace, one of the investing world’s harshest climates.

Facebook has several key factors working in its favor. It has the eyeballs of the Western world, with more than 500 million registered users. It recently surpassed Google as the most-visited site on the web. And most importantly, the folks running Facebook have access to the personal information, likes and dislikes of a majority of the consumers in the United States and beyond. To say this information is valuable is a gross understatement. Targeted advertising is king on the internet, and Facebook’s platform is perfectly designed for businesses to strengthen their bonds with new and loyal customers alike.

With annual revenue reportedly in the billions, Facebook is the dominant social media force even though its IPO is potentially more than a year away. We don’t have any detailed numbers yet, but it’s safe to say there will be real value in this company when shares become available to the public.

After Facebook comes a long line of coattail riders, eager to cash in on the social media trend. Yet unlike Facebook, I can’t envision scenarios where most of these companies can maintain significant  market shares and sustained profitability:

• Social Media Games – I’ve heard that social media games — such as the infamous time-waster Farmville — can be fun and addictive. Yet I’m not seeing any small-cap game developers that are positioning themselves at a true competitive advantage. Games are fads, and frankly, so are many of the penny stock gaming companies out there. Most are far from profitable, and probably even fewer will show investors significant returns.

• The Daily Deals – Groupon is the king of this category, where subscribers are emailed daily coupons to local restaurants and shops. It’s a popular service, but I don’t think it has the barrier to entry similar to Facebook. Several Groupon copycats have emerged, and I doubt consumers will immediately declare loyalty to one particular provider. Shoppers love bargains, so they will flock to the best deal. The source is irrelevant.

Groupon’s IPO is tentatively scheduled for later this year, and could raise more than $1 billion, according to Reuters. I expect we will continue to see increasingly ridiculous numbers tossed around as the company gets closer to its IPO date, since news outlets have already rumored valuations of $15-$20 billion.

• Twitter – Telling the world what’s happening in 140 characters or less might have sounded like a silly idea five years ago. But it’s become insanely popular — and probably the best social media company following Facebook in the social media sphere. Twitter is actually a profitable company that has rebuffed buyout and investment rumors, with co-founder Biz Stone claiming that the company is profitable and needs no additional funds to grow its business. The strongest argument for Twitter is that it invented a social media genre and monopolized it from day-one. Unfortunately, you probably won’t get the chance to invest in this phenomenon anytime soon.

Sincerely,
Greg Guenthner
Penny Sleuth

April 27, 2011

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