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Watch LinkedIn for Signs of Social Media Bubble

The glut of sales and initial public offerings (IPO) in the social media sector expected during this year could be indicative of a tech bubble similar to a decade ago, analysts have told CNBC.com.

LinkedIn
CNBC.com
LinkedIn

Last week, Microsoft bought Skype for $8.5 billion, a figure widely regarded as over-valuing the company significantly while Thursday sees Linkedin, the business professionals' social networking website, join the New York Stock Exchange.

LinkedIn announced Tuesday it would offer 7.84 million shares priced in a range of between $42 and $45 per share, valuing the company at $3.36 billion, higher than the initial price range of between $32 and $35 a share.

The company earned $15.4 million in 2010 on net revenue of $243 million from roughly 100 million users. But it warned it expected revenue growth to decline and costs to rise as it pushes recruitment and reinvests in the business. It also said it would make a loss this year.

Many other companies, among them Groupon, Facebook and Twitter, and their backers will be watching that IPO extremely closely in order to gauge investor appetite for their stocks.

That there will be plenty of appetite for such shares is not in question but Arun George, technology analyst at Altium Securities, warned that they may be massively over-valued.

"I think they will be over-valued, whether that's through an IPO or these companies being bought outright. Private Equity investors know they are going to get a return," George told CNBC.com.

"You want to be one of those investors now, but once it's offered in an IPO or bought, that's when you want to step away," he said. "So the valuations, if you're an investor now, will mean you will make a lot of money. But afterwards at the IPO stage you would struggle to make money."

The initial flotation prospectus had valued LinkedIn at around $3 billion – or about 12 times sales - which is comparable to Skype's takeover by Microsoft at 11 times 2010 revenue.

But those valuation are still cheap when compared to the IPO of social network Renren - China's answer to Facebook - which valued the company at 78 times 2010 revenue or $748 million.

Investor Appetite

Shares of Renren surged 29 percent in its IPO on May 4. Strong demand for the company - which is not profitable, but will be in profit "very soon," as chief executive Joseph Chen told Reuters – was a strong indicator of investor appetite for social media companies.

The stock rose as high as $21.93, or almost 56.6 percent, above its $14 IPO price in its first day of trading before closing at $18.01, or 28.6 percent above the IPO price. Renren raised $855 million in its IPO. But ever since that first day it has fallen and shares are now below the IPO price, sitting around $13.

Discount retail vouchers website Groupon is next in line to launch an IPO after LinkedIn, having rejected the advances of Google late last year, while Facebook is expected to float on the market sometime later in the year.

Both Twitter and Zynga have also attracted interest from investors betting on social media providing a significant return on investment.

As a result their shares, traded in markets for private investors, are commanding multibillion-dollar valuations, with Goldman Sachs estimating that Facebook could hit a valuation of $50 billion when, or if, it decides to float.

How Big a Risk?

Although there are similarities to the dot.com bubble, both Anthony Miller, managing partner at Techmarketview.com and George see the bubble being restricted to the social media space, suggesting there should be no risk of contagion to other tech stocks.

"In terms of what we are now seeing it's more a new media bubble than a tech bubble because the stratospheric valuations are limited to that sector compared to ten years ago when everybody's valuations went up," Miller told CNBC.com.

"There are a lot of people that share the view that we're seeing a social media bubble but it's also very difficult to know when time your exit from that," added George.

There was "a lot of faith" being shown by Microsoft in Skype by valuing it at $8.5 billion and it was difficult to see Microsoft ever seeing a return on such a high level of investment, Miller said.

George went much further calling it "a desperate move by Microsoft".

"Skype had a lot of interest from Facebook and Google, possibly meaning there was a serious bid from one or the other," he said. "Microsoft going in with such a high bid would suggest they wanted to keep both of their rivals out."

"It's clearly overvalued as something like 11times sales. They can possibly get some value from it by integrating Skype into their mobile platform but they have not been very clear in terms of what we can expect out of it," George added.

Competition Gets Ugly

In many ways such a high valuation illustrates the competition between some of the largest players in the technology space. Google's $1.654 billion acquisition of You Tube is another example.

And an ugly side to that increased rivalry was revealed when Facebook admitted that it had hired a public relations firm to generate stories that would criticize Google over the use of personal information.

But it is not as if mistakes have not been made already in this area: News Corporation's $580 million acquisition of MySpace has been cited by analysts as the clearest example of how to get things very wrong.

Having expanded aggressively into Europe, soon after its acquisition by News Corp, the social networking site effectively closed down its European operations at the end of 2010, withdrawing to concentrate on its core market in the US.

However, MySpace's decline continues apace. Only two weeks ago News Corp announced profits for the first quarter had tumbled 24 percent as losses at MySpace erased strong gains by the media company's television group.

The business unit that includes MySpace reported an operating loss of $165 million because lower advertising and search revenues were only partly offset by lower expenses, the company said.

"MySpace was a clearly a classic case of how not to make an acquisition but you can't say MySpace means the whole social media space will end up the same way," George said.

"You need to have a proper strategy. You saw that with ebay when they bought Skype as well. They thought they could incorporate Skype into their website and users would talk to each other over Skype during transactions but that never really happened," he added.

Give It Two Years

Many analysts agree that a bubble exists but it is extremely difficult to predict what would happen next.

"We are in a bit of a boom in cloud media and mobile connectivity and it does not look like the enthusiasm for that is going to wane any time soon," said Miller.

"I don't think this is a generic tech bubble which would most definitely burst. But this is far more difficult to predict in terms of software start-ups that are doing cloud software and there is so much activity around it and companies that are doing well in extracting exuberant valuations," he added.

George said that he was "fully expecting more activity in the social media space."

But he warned there were particular companies that posed problems for investors, citing Groupon as an example.

"One bubble is Groupon. I'm a user of it and after a month I got bored. The issue with Groupon is that it's a model that can be easily replicated," he explained.

"And some retailers have had bad experience with Groupon and lost a lot of money so it's not a safe bet in terms of having a secure customer base."

Meanwhile, he said other companies such as Facebook were "trying to stay relevant" but that it was inevitable that at some point there would be fatigue in the social media space.

"It is still in the hype cycle and will stay there until some of these companies start IPOs and then we will see what these companies are making and what they are expecting," George said.

"That's when disappointment will set in and that's when the fatigue will set in. I would give it another two years at most."

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