Social Networking Bubble Inflating

Technology companies like LinkedIn, Pandora, Groupon and Facebook are being valued at mind-boggling revenue multiples. In the face of relatively meager earnings, the fast-growing niche of social networking looks severely overvalued, bringing back memories of the last decade's dot com bubble.

Technology companies like LinkedIn, Pandora, Groupon and Facebook are being valued at mind-boggling revenue multiples. In the face of relatively meager earnings, the fast-growing niche of social networking looks severely overvalued, bringing back memories of the last decade's dot com bubble.

Over the past couple of weeks one must increasingly have been under the impression that technology history may be about to repeat itself. Again, technology companies, many of which are still in their start-up stages, are being valued at mind-boggling revenue multiples that the respective companies and venture capitalists are trying to justify by pointing to web statistics such as page views, unique visitors, registered users or even entirely new metrics they invented themselves ("income before expenses", as they are often called). Groupon, for instance, introduced a metric called "adjusted consolidated segment operating income" (short: Acsoi). Supposedly, Acsoi is the firm's operating profit minus its marketing and acquisition expenses. Under US accounting standards, Groupon shows a loss of more than $400m, using Acsoi this magically turns into a $61m profit.

What do these income-before-expense-metrics tell about the companies' financial situations and outlooks? This is a rhetorical question, of course, with the answer becoming evident when looking at technology stocks in the early 2000s. What they are supposed to cover up, is that most of the new web start-ups are severely overvalued not only in terms of the 2010 revenue multiples, but also based on multiples derived from current 2011 revenue outlooks. Is it the year 2000 all over again?

Almost. This time it is not the entire technology sector that is overvalued, but it is the relatively narrow niche of social networking firms. The shares of professional networking site LinkedIn, for example, jumped more than 150% to $122.7 on the day of its IPO on May 19, 2011, only to fall back to $67.92 as of this writing. LinkedIn reported a profit of $3.4m last year, mostly from advertising and membership fees. This is a tiny profit, considering the firm's current market capitalization of $6.4bn. Pandora, an online radio site which is valued at $4bn despite revenues of little over $100m last year, benefited from LinkedIn's IPO too. But under its current licensing terms, the more songs users listen to, the more Pandora ends up paying in royalty fees. This deal alone lacks entrepreneurial brains, in my opinion.

Granted, social networking firms are growing fast. But as long as web 2.0 companies are not able to translate their extreme popularity and growth into sustainable profits, I prefer to remain sceptic. Advertising alone cannot be the answer to this problem. With the increased use of ad blockers and general "ad blindness" by today's internet users, relying almost exclusively on paid ads will turn out to be a dangerous business model. Even Google has realized this by now and is beginning to branch out into new markets such as cloud computing, operating systems and telecommunications.

Unfortunately, it is not just the absence of robust business models that should caution potential investors. The aforementioned creativity in terms of financial accounting and reporting is just as big a problem. As an investor, I choose not to trust a company that is desperately trying to cover up losses and turn them into profits using non-standard accounting rules.

Recommended reading:
- Accidental Billionaires: Facebook (Paperback) | (Kindle Edition)
- The Google Story (Paperback)(Kindle eBook)
- Wikinomics (Paperback) | (Kindle eBook)

Facebook Usernames, or Vanity URLs

FacebookToday, I successfully applied for my so-called Facebook username, which is actually a vanity URL. The new URL of my Facebook profile is Facebook.com/DominikMueller.

I think it's been a great idea of Facebook to introduce these usernames, because the actual profile URLs are very long, cryptic and impossible to type in. Other social networking sites like LinkedIn and Twitter have been using vanity URLs for a long time.

According to Facebook, you can choose a username on a first-come, first serve basis. You can apply for your personal username on Facebook.com/Username. If I'm not mistaken, it's also possible to secure generic keywords instead of a username or your real name. For example, it should be possible to apply for terms such as Facebook.com/DomainSeller, .../TravelAgent, .../Money and so on.

If you already have applied for a username, did you get your username of choice? And what is it?

Microsoft gets Facebook stake, beats Google

FacebookMicrosoft (NASDAQ: MSFT) has beaten Google (NASDAQ: GOOG) and invested $240 million for a 1.6% stake in Facebook. This would value the social-networking site, which was founded in 2004, at $15 billion. Microsoft also has an advertising deal with Facebook until 2011, which it expanded to monetize the traffic of international versions of Facebook, too, which the social network is planning to launch shortly. About 60% of Facebook's users are coming from outside the U.S.

According to the WSJ, the startup expects to break about even on a cash-flow basis this year, with revenue of $150 million.

Here's the official press release from Microsoft and Facebook:

PALO ALTO, Calif. and REDMOND, Wash., Oct. 24 /PRNewswire-FirstCall/ -- Facebook(R) and Microsoft Corp. today announced that Microsoft will take a $240 million equity stake in Facebook's next round of financing at a $15 billion valuation, and the companies will expand their existing advertising partnership. Under the expanded strategic alliance, Microsoft will be the exclusive third-party advertising platform partner for Facebook, and will begin to sell advertising for Facebook internationally in addition to the United States.

"We are pleased to take our Microsoft partnership to the next level," said Owen Van Natta, vice president of operations and chief revenue officer at Facebook. "We think this expanded relationship will allow Facebook to continue to innovate and grow as a technology leader and major player in social computing, as well as bring relevant advertising to the more than 49 million active users of Facebook."

"Making this investment and expanding this partnership will position Microsoft and Facebook to better take advantage of advertising opportunities around the world, and is a great win for not only for our two companies, but also our collective users and advertisers," said Kevin Johnson, president of the Platforms & Services Division at Microsoft. "We have partnered well over the past year and look forward to doing some exciting things together in the future. The opportunity to further collaborate as advertising partners is a big reason we have decided to take an equity stake, and is a strong statement of our confidence in the long-term economics of this partnership."

Facebook continues to experience strong growth both in the U.S. and international markets; 59 percent of Facebook's users are outside the U.S. With an average of 250,000 new users registering each day, Facebook continues to be one of the most-trafficked sites on the Internet.

On Aug. 22, 2006, the companies announced a U.S.-only strategic alliance that named Microsoft the exclusive provider of standard banner advertising on Facebook using Microsoft's digital advertising solutions and the Microsoft(R) adCenter platform. In early 2007, the terms were extended to 2011.

The WSJ has another article reporting that Facebook is seeking additional funding beyond Microsoft's investment. The Palo Alto-based company is looking to raise about $260 million from hedge funds and private-equity investors. After all, the software giant's $240 million investment is significantly less than the $500 million to $1 billion investment many industry experts were expecting.