Social Network Frenzy Signals Another Tech Bubble - InformationWeek

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Software // Social
08:38 AM
Rajan Chandras
Rajan Chandras

Social Network Frenzy Signals Another Tech Bubble

Some say the likes of Facebook, Twitter and Groupon deserve to be measured by a different yardstick. But that's what they said about the infamous flameouts of ten years ago.

Even as they bask in the warm glow of high market valuations, companies like Facebook and Twitter are raising concerns that, barely ten years later, we are letting ourselves in for yet another technology bubble.

The companies that are leading a nearly revolutionary change in the way we use the Internet have a few things in common. For one, these companies are young: Facebook was established in 2004, Twitter in 2006, and Groupon as recently as 2008.

Then -- and perhaps most importantly -- they are outstanding examples of Web 2.0: stunning new ways to exploit the same old Internet; "under the surface" business models that defy conventional wisdom. A Web site that doesn't do much more than allow people to put up their personal details -- blasphemy -- for everyone to see. A service that merely lets people send -- and sign up for -- short messages. And one that will send consumers a different coupon every day (yawn), but only if sufficient consumers are interested.

One last thing: These sites would quite likely be dead in the water without the explosion of mobile computing. They bank -- quite literally -- on ordinary folks like you and me growing increasingly accustomed to living our lives on the go, using our mobile devices to buy things, stay informed and generally share our lives with the world at large.

There's no denying that it's their time in the sun, and now they want to capitalize on the opportunity -- again, quite literally. They are all headed to the capital markets where a warm welcome awaits them in the form of unprecedented market valuation, whether realized through an eagerly anticipated public offering (like Groupon, Twitter and LinkedIn) or enthusiastic private placement (like Facebook).

But there are murmurs of concern over their high valuation, and questions are being raised about the potential domino effect on other Web 2.0 ventures that might also vie for their slice of the capital pie -- but without the dominant position or established presence that these few companies have.

Goldman Sachs, which is helping Facebook raise finance through private equity placement, has valued Facebook at a "vertigo-inducing price,"as a New York Times writer put it, of $50 billion. At revenues of about $1.2 billion last year, this sets Facebook's valuation at about 25 times its revenue. In comparison, reports Reuter, Google is valued at merely nine times its revenue, and Amazon even less. The placement also values Facebook higher than companies like ebay and Time Warner.

Using another metric, Facebook still looks overvalued: it generated $4 of revenue per user, which compares poorly compared with Yahoo ($8 per user) and especially Google ($24 per user).

Facebook is on a hot streak, which might justify its enthusiastic reception in the capital markets: It recently passed Google as the most visited Web site in the United States. But what about other Internet 2.0 vanguards like Twitter and Groupon, which have estimated valuations at close to $4 billion and $8 billion respectively? Or LinkedIn, which is planning to go public this year? Or internet gaming firm Zynga, which by one measure exceeded established leader Electronic Arts in market valuation?

The key question is, do these (and other such) companies have a sustainable business model, or will they turn out to be avatars of WebVan, the online grocer that generated huge attention and capital valuation in the 1990s, and then went down flaming in an exemplary fashion?

While some observers are cautioning against market machinations and "irrational exuberance" (that over-used phrase), others have a different take: It would be a mistake to measure a company like Facebook by conventional yardsticks. Social computing pioneers like Facebook and Twitter, says one venture capitalist, should be viewed in terms of their business-transforming potential and their ability to leverage the social network fabric.

In other words, these companies stand alone. They are blazing a trail that leaves others in the dust. To measure these companies using conventional metrics -- and against conventional business models -- would be incorrect.

Pretty much what they told us about WebVan back then.

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