Sunday, July 3, 2011

Facebook, Twitter, Linkedin: Are they worth it?

IPOs are back in the reckoning. And this time it’s none other but Uncle Sam that’s the epicenter and the boys raising the bars are from the dot-com business. With most of them having or claiming to have gained the critical mass (for the much abused “network effect”), it’s not a surprise that the valuations are simply going through the roof. The four of the biggest newsmakers are Facebook, twitter, Linkedin and Groupon. Though likes of Skype, Zynga, Yandex (Russian search engine), Pandora (music streaming company) etc. have been in the news as well. 

So, what’s the fuss all about? For that let’s have a look at the user base, revenue and the predicted valuation for some of these tech firms.

User Base
90 m
100 m
279 m
700 m
300 m
83 m

Even a cursory glance at the numbers is good enough to show that while there is a huge user base but revenue and income of the firms doesn't match up to their valuations.While some of the firms like Pandora, Linkedin have already unlocked some of the wealth by getting listed, others like Groupon, Facebook, and Twitter are looking to derive optimum value for their shares by going public soon.

But, is a large user base enough for such mind-boggling valuations? It would be hard to value these firms by the conventional method as they are relatively recent phenomena with most of them less than a decade old. Thus they are estimating their value on the basis of exponential growth in the user base, pervasiveness of their usage and the “buzz” that they have created. 

A depiction of "How a tech bubble takes place"

Let’s now discuss why some of the firms may not to justify such valuations.

Facebook: Undoubtedly the one with the largest user base and great capacity to engage. After all, 700mn is not a small figure. But their main source of revenue are the ads that you see on your FB page and corporate pages. But have you ever bought something after clicking on those ads? I haven’t. With the recent spam attack, people are even more apprehensive. So while FB pages may be a great platform for engaging with the customers, it may not yet be the best place to sell your products. And with sites likes groupon, snapdeal already up and running and google ads doing well, direct sales seems to be a tough if not lost battle for FB. There are reports of millions of users quitting facebook in the US and with the launch of Google+, $100+bn seems to be a far cry. 

Twitter:  It is commonly referred to as the most undervalued of these tech firms. Despite having great reach and engagement capability, Twitter is a known laggard when it comes to revenue generation. The three main sources of revenue for twitter are firehose (mainly for real time search engines), promoted trends, and promoted accounts. These revenues are mainly data driven or are in the form of limited and unobtrusive marketing messages. But a recent FT report says that they plan to place “promoted tweets” in the main “stream” of tweets as that’s the most active part. This shows their desperation and could prove to be controversial with the users. 

Linkendin: The one that has set the IPO stage on fire with its blockbuster opening. Despite being the least engaging amongst the sites, one thing that sets this site apart is the target segment i.e. the corporates who have deep pockets. It has managed positive cash flows which is a rarity but still $8bn isn’t a small number by any means. Even the share price seems to be cooling off from the highs of $120 as it’s now trading at $90 odd. This post from the legendary Aswath Damodaran sheds more light on its valuation. 

You can find a discussion on Groupon in this post. And most of you must be aware that Youtube is struggling to break even. With nothing much to look forward to in other sectors, the tech firms seem to have caught the fancies of the investors. But only a sound business model and rational valuation will ensure that they will create value for their shareholders as “barrier to entry as well as exit” aren’t that huge. With ever rising privacy concerns, the road ahead may not be that easy for these firms of “open information era”. For now let’s keep our fingers crossed.

1 comment:

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