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Are Social Media Services the Next Tech Bubble?

June 30, 2011 at 12:00 AM EST
The estimated value of tech companies such as Facebook, Twitter and LinkedIn is soaring, but could another tech bubble be building? Ray Suarez discusses the social media services that are at the center of this question with Fortune magazine's Jessi Hempel and Forrester Research's Josh Bernoff.
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JEFFREY BROWN: Now, prices for tech companies are soaring, but could another bubble be building?

Ray Suarez has the story.

RAY SUAREZ: The numbers are astounding. Companies and individual investors are paying billions of dollars for the next generation of tech enterprises, and, often, the valuations dwarf the revenues.

Microsoft bought Skype for $8.5 billion earlier this year. Skype’s revenues are less than a billion dollars annually. When LinkedIn went public, it was initially valued at $9 billion — its current profit, just $12 million a year. There’s talk of Facebook selling for more than $75 billion next year.

Along with the excitement, there are cautionary tales, too. MySpace, the social networking site, sold yesterday for just $35 million, after it was expected to fetch $100 million at auction. Six years ago, News Corp. bought it for $580 million.

We look more closely at all of this with Jessi Hempel, who follows the tech world for Fortune magazine, and Josh Bernoff, a senior vice president at Forrester Research and the author of two books on social media.

Josh Bernoff, let’s start with you.

Are we watching the inflation of tech bubble two?

JOSH BERNOFF, Forrester Research: Well, I certainly think that there’s no rational way to understand these valuations.

I want to be clear here. Social is extremely exciting. There’s a lot of business perspective, a lot of optimism that goes along with it. But I think these valuations are based on where people think the next buyer will come from, and not on where the actual revenues of these companies are going.

RAY SUAREZ: Jessi Hempel, is it a little different this time, in that some of the companies we are talking about actually do have revenue streams and do make money?

JESSI HEMPEL, “Fortune”: That’s exactly right.

I agree with Josh. I think that it’s impossible to explain exactly what’s going on here with the exuberance, but this is not the first bubble. And I think, when you say bubble, people immediately think Web 1.0. They think Pets.com and Boo.com.

This is not that. These are real businesses. So…

RAY SUAREZ: But, still, aren’t these — when you compare revenues, for instance, to estimated earnings in the future, those numbers are — well, they don’t line up in the way they do in conventional businesses. How do you explain that?

JESSI HEMPEL: Well, they certainly don’t line up in the way they do in conventional businesses.

I think one thing you’re seeing is the product of an IPO market that really hasn’t existed in last few years. So you see a lot of pent-up demand for these high-growth tech companies. And there haven’t been a lot of companies to invest in.

So, yes, you see high valuations, perhaps valuations that seem relatively optimistic for the actual revenues these companies are displaying now. But I think that if you peel that back, what you see at these companies are often very strong, very nascent businesses with something Web 1.0 didn’t have, which is massive numbers of users.

I mean, everybody is on the Web today. And you see the start of real revenues and real profits, which is something that you didn’t see first time around. And I also think that you see the Web coming off of our computer screens and entering our world in a different way.

I mean, you look around in today’s world, most people have a computer in the palm of their hand in the form of a smartphone. And you’re starting to see commerce develop from that palm of your hand, and you’re starting to see new advertising models that go beyond the banner ad to make real money.

And I think that people are pretty excited about those building blocks and optimistic that these companies, while they perhaps are nascent now, really do have the fundamentals that are going to make them explosively — explosively profitable.

RAY SUAREZ: Josh, when you see some of these gaudy numbers talked about, $75 billion for Facebook, when a company isn’t publicly traded, how do they come up with a figure like that? How do we know?

JOSH BERNOFF: Well, it’s just like any other market. It’s a question of supply and demand, the supply of shares that are available and the demand of investors that want them.

What’s changed here is that it used to be, before a company went public, that only sort of experts, people like venture capitalists, could decide on where they thought the company was going. Now you can go and buy shares that may have been made available by some Facebook employee in places like SecondMarket and SharesPost even before the company is public.

And, as a result of that, investors who don’t have a whole lot of information that they would have about a public company are saying, you know, I have to get in on this. I don’t care what the price is. And that’s really what drives some of these valuations.

RAY SUAREZ: But when a company is public, it has to disclose a lot of things about its interior workings, so that someone who buys a share has some transparency.

Does this secondary market sort of fly under the Securities and Exchange Commission radar?

JOSH BERNOFF: Well, in order to be involved in the secondary market, you basically have to say, I am an experienced investor and I understand the risks.

But, in fact, there are enough people involved here that are not professional venture investors that you do have to wonder about that. I think the SEC needs to look closely at these secondary markets, because people are buying things that don’t have the same audited financial statements and the same comparables that you can look at with other similar companies that you get when you’re looking at a company that’s traded on a public market.

RAY SUAREZ: Jessi, apart from the exuberant headlines having to do with social media, the news this week is dominated by what happened to MySpace.

Is that a cautionary tale for some of these companies, or really a story all its own because of the way the business was handled?

JESSI HEMPEL: Well, I think it’s a cautionary tale for the big media companies and the big tech companies who perhaps wish to acquire a lot of these companies.

They’re a lot harder to monetize than you think. And this is a business that moves very fast. And when you look at something like MySpace, when it first sold to News Corp. in 2005, there was much excitement about the fact that it had the most users and it was the biggest.

But we saw Facebook, at that time very tiny, nip at its heels and simply execute better and fast on the business. And MySpace lost because News Corp. failed to execute, in my opinion, and because they didn’t focus on the technology at a time when their competitors did.

Now, I think that’s a danger for any business in any industry. I don’t think it necessarily is a suggestion that we’re going to see the explosion of a number of healthy — potentially healthy businesses in this field.

RAY SUAREZ: And, Josh, when we talk about MySpace, we’re looking at, as Jessi mentioned, a company that was a leader in its field. So, as they always say in the financial services commercials, past performance is no prediction of future values for these companies.

But you have got — you have got companies that now have no revenue stream and are still being valued in the tens of millions, hundreds of millions of dollars.

JOSH BERNOFF: Well, I think, if you look at MySpace, yes, it was the leader, but it was the leader at a time when social was very, very new and it wasn’t really clear where things were going. In fact, you saw that a company that executed better, Facebook, took things over there.

If you look at the companies that are coming out now, companies like LinkedIn, for example, LinkedIn has a very mature model. They have dominated the market for business-to-business social networking. The challenge there is in figuring out how best to monetize all of this activity that’s happening.

But you can make a little bit better estimate of where the company is going. And I also think no one is going to come and do to LinkedIn what Facebook did to MySpace. LinkedIn has got itself a pretty solid position there.

RAY SUAREZ: And tiny revenues compared to the valuation that it’s been given by the marketplace.

JOSH BERNOFF: Yes.

Well, I think people looking at these companies and trying to decide what they’re worth need to look at three things. One, how many users are there? How many people have signed up to participate? Two, how much time are they spending there? Because it’s the amount of time that they spend that determines how much value can be gotten out. And the third is, how can we actually monetize that time spent through advertising or premium services?

If you look at LinkedIn, it’s really done very well on the first part, but the time spent and especially the monetization, they have a lot of work to do. And this is why, when you look at the valuation that is assigned to it, there are people who are very optimistic about where the money is going to come from based on the time spent.

And I would sort of like to see a little bit more proof that they have got better ways to monetize before I believe it’s worth what the market is saying it’s worth.

RAY SUAREZ: Well, to be continued.

Josh Bernoff, Jessi Hempel, thank you both.

JESSI HEMPEL: Thank you.

JOSH BERNOFF: Thanks.