The buzz over social media companies continues to grow and the leading players in the space are now more valuable than a large number of publicly-traded companies that have been around for many years. This is surprising many investors given the fact that many social media firms having existed for less than a decade and possess business models that are still evolving and far from posting consistent profitability.
TUTORIAL: The Industry Handbook: The Internet Industry
The current argument is that the valuations being placed on social media firms are nothing short of crazy and their values will eventually burst, as happened with many online firms back during the dot-com bubble. To help answer whether social media is a current bubble waiting to pop, below is a comparison of five leading social media firms and five stable, profitable companies with similar valuations. (For related reading, see A Primer On Investing In The Tech Industry.)
Facebook and Amazon.com
Facebook was only founded in 2004 but its meteoric rise in popularity with a 750 million person user base has meant the firm receives the lion's share of attention and buzz when it comes to its future potential to make money. Current estimates place Facebook's valuation at around $100 billion, or roughly 26 times revenue, according to a recent article in financial publication Barron's.
That valuation exceeds Amazon's current market capitalization of just under $97 billion. Amazon looks like a true steal at a price to sales multiple of less than three and reported more than $1 billion in profits over the last year. Facebook is thought to be able to generate sales close to $7 billion and more than $3 billion in cash flow next year, which would make its valuation more reasonable, but so far these are just estimates and there is quite a wide range of projections over Facebook's sales and earnings potential going forward. (For related reading, see What We Can Learn From 2011 Tech Leaders.)
Groupon and Dell
Late last year, Google reportedly offered to buy Groupon, which invented a deal-of-the-day email business model when it was founded in late 2008, for $6 billion. Its estimated market value has since increased markedly and currently stands at around $30 billion, according to Barron's..
To put that into context, computer and tech giant Dell is currently worth just over $32 billion and has a sales multiple of less than four. Dell is familiar with competition and has to duke it out with Hewlett-Packard and overseas firms including Lenovo to fight for computer market share. It is also diversifying into IT consulting and servers. Groupon is just starting to face competition, with the likes of LivingSocial and a wide array of local firms in the cities it currently operates in. Back in June, Groupon filed to go public but is thought to still be operating at about break even as it is still developing its operations. (For more on Groupon, see Is Groupon Good For Business?)
LivingSocial and Research in Motion
Speaking of Groupon rivals, LivingSocial is one of its largest and was founded in February 2008. It initially started as a social discovery site where users review movies, books and music, but quickly evolved into a daily deal email and alert provider. It is currently estimated to have a market value close to $15 billion, or 15 times sales.
This valuation places it ahead of Research in Motion, which is best known for its Blackberry smartphones. RIM's current market value is less than $14 billion and it sells for less than its sales of nearly $21 billion. The contrast in RIM's business to LivingSocial is stark as Blackberry is struggling to compete with Apple while both Groupon and LivingSocial are growing rapidly. However, RIM reported more than $3 billion in profits over the last year while LivingSocial is not believed to be profitable right now.
LinkedIn and Paychex
LinkedIn is more seasoned that most social media firms as it was founded in 2002 and officially launched in 2003. It is also one of the first firms in the industry to have gone public, which it did back in May. LinkedIn currently boasts 100 million members in 200 countries that network professionally on its website. Its current market capitalization is around $10 billion. Sales are growing rapidly but it is currently not profitable, though it could be by 2012.
This valuation is comparable to Paychex, the second largest payroll processor behind Automatic Data Processing. Paychex currently sports a market cap just north of $10 billion, trades at five times sales and reported net income of more than $500 million over the last year. Analysts expect Paychex to grow sales by about 6% this year as its fortunes are being held back by high unemployment in the United States. (For more on Linkin's IPO see, What LinkedIn's IPO Means For Social Media Sites.)
Twitter and VeriSign
Twitter bills itself as a real-time online network that lets users connect in real time. Its tweets consist of "small bursts of information" that must be 140 characters or less. The company was founded around 2006 and has grown to an estimated market value of $8 billion, or more than 53 times sales. Like many of the social media firms, Twitter is not currently profitable.
This valuation exceeds that of VeriSign, which is publicly traded and has a current market cap of almost $6 billion. VeriSign maintains website domains and registries, such as the .com, .net, and .gov, the first two of which contain nearly 110 domains.
The Bottom Line
It does seem suspicious that Facebook, Groupon, LivingSocial, LinkedIn and Twitter trade at the same valuations as firms with solid operating histories that are consistently profitable. They could end up justifying their currently lofty valuations, just as Google and Amazon did, but investors will need to choose carefully to find the few winners in what is likely to be an industry that eventually has many losers. (For related reading, see 5 Emerging Social Media Companies You Need To Know.)
Disclosure: At the time of writing Ryan C. Fuhrmann was long shares of Dell and HP but did not own shares of any other company mentioned in this article.
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