California-based LinkedIn's spectacular listing yesterday, which saw its share price double on the first day of trade, has sparked fears that the social networking bubble may burst, turning into another dot-com bust.
LinkedIn's debut on the New York Stock Exchange comes only days after Microsoft shelled out $8.5 billion to buy Skype, and follows news that Facebook is worth about $50 billion, and that Twitter had spurned a $10 billion bid from Google.
However, there are questions as to how social media sites can turn their millions of subscribers into cash. If these companies can't provide returns, investors will lose faith, walk away and leave behind worthless shells.
The hype around social networking companies is reminiscent of the large IT crash at the turn of the millennium.
About a decade ago, investors piled millions into IT stocks, believing there were limitless wealth-creation opportunities to be made through the Internet. However, many IT companies didn't make any money, resulting in a crash - the dot-com bomb - which wiped out several stocks, leaving only a handful of survivors.
Hot stock?
LinkedIn, founded in 2002, offered its initial stock at $45 and closed its first day of trading at $94.25. This is a phenomenal premium on its earnings, considering it only turned positive last year, when it reported a net gain of $15.4 million, compared to a loss of $3.8 million in 2009.
Kaplan Equity Analysts MD Irnest Kaplan says the share price represents “massive enthusiasm” for social media companies. He says the market is either “bubblish” or honestly believes LinkedIn will deliver massive profit growth over the next few years.
LinkedIn's prospectus warns: “We have a short operating history in a new and unproven market, which makes it difficult to evaluate our future prospects and may increase the risk that we will not be successful.” It has more than 100 million members in 200 countries.
However, LinkedIn expects its revenue growth rate to decline as it is investing for future growth and doesn't expect to turn a profit this year. The company also expects to face increasing competition in the market for online professional networks.
Kaplan says there are similarities to LinkedIn's high share price and the dot-com bust. Back then, companies were valued far higher than they should have been.
Everyone clamoured to have stock in companies they didn't understand, but thought they had limitless earning potential, says Kaplan. “Ten years later, only a handful succeeded; the rest were pie in the sky and didn't produce any numbers.”
Investors believe LinkedIn has the potential to double revenue this year, based on its first quarter revenue of $94 million, compared with $243 million for all of 2010, says Kaplan. In addition, LinkedIn could benefit from some of its costs being fixed, which will allow profit to grow at a faster pace than revenue, he says.
The market will have to wait and see whether the excitement around LinkedIn's listing is the start of another bubble, says Kaplan. He explains stock crashes happen when share prices are high and aren't backed up by earnings.
The challenge, says Kaplan, is for social media companies to turn their user base into something that can be successfully monetised. He points out that this is not something every Internet start-up gets right.
Research house Forrester has also called attention to whether Web-based companies can generate revenue. In its commentary on Microsoft's bold buyout of Skype, it says Microsoft won't be able to “magically turn this wealth of eyeballs and conversations into a revenue stream”.
However, Forrester says: “There is considerable value in Skype, provided Microsoft's consumer product strategists successfully integrate Skype's communications tools deeply into Xbox Live, Windows Phone, and Office.”
More to come
Pieter Kok, IDC's research manager for IT services and software in Africa, believes the landscape is shifting. Younger people are entering the job market and want access to the same social media tools they have been using.
Kok says organisations must find ways of turning social networking into a productivity accelerator, instead of seeing it as hampering workflow. “There is no way you can deny it anymore.”
IT companies are seeing the shift and want to stay at the forefront of technological shifts, which is why there is a buzz around buying out social media groups, notes Kok. He anticipates the excitement will continue, and more mergers and acquisitions will happen. “Lots of businesses are going to sit up and listen.”
Social media will continue to evolve, adds Kok. He says the market hasn't reached the point where the bubble will burst. “The bubble will just continue to grow and grow and reshape itself.”
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