3 Reasons Social Media is the Next Bubble

Let me state this very clearly: Social media has produced the most profound changes in communications, news dissemination and social interaction—period.

Loic Venance | AFP | Getty Images

Twitter has certainly changed the way many of us do our jobs, companies communicate with customers and investors and has even helped lead to the overthrow of governments. I’m a huge fan.

But this I also know: Right now social media (the values of their not ready for prime-time-traded stocks, not the companies themselves) smacks of the next big bubble.

That goes for Facebook, Twitter, Zynga and any other company whose shares trade on the unregulated, speculative and sprung-out-of-nowhere secondary markets for private shares—no matter what the venture-capital valuation may imply. (Yes, that includes Groupon.)

Here’s why:

#1: No matter what you may read, nobody really knows what Facebook, Groupon or any of these companies are really worth. Reality: Nobody will, unless they’re sold or do an IPO. And even then, the valuations may be exaggerated.

#2: Normally, unless there is a private transaction, insiders don’t get a crack at selling until there is an IPO or their shares are privately bought in. And if and when there is an IPO, it’s an enormous red flag when corporate officers or other top employees sell on the deal. Normally there’s a lockup that lasts for six months, even longer.

With the creation of secondary markets, unknown insiders in the hottest (and often very young) social media and tech companies anonymously are selling shares before a deal, assuming there will even be one. Reality: If they thought the companies were worth more, you really think they’d be running for the exits?

#3: Investors in the secondary markets have no idea what they’re buying beyond the “story,” and don’t appear to really care. They just want in without even having the opportunity to see a single financial statement. Reality: That’s simply the most bubble-brained reason to buy a stock. Ever.

My take: Current valuations on these social media stocks may ultimately turn out to be bargains, but make no mistake about—this is a bubble in the making. The only difference between this bubble and others is that, thanks largely to the secondary markets, this one has had an unusually early head start.

Questions? Comments? Write to HerbOnTheStreet@cnbc.com

Follow Herb on Twitter: @herbgreenberg


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