This past week marked two important events for Internet investors: Mary Meeker published her 2012 Internet Trends, and Goldman Sachs held its Private Internet Company Conference. As always, both were bullish: the trends look great, and the reports from private companies reflect growth and innovation in the sector. But when you look at the prices of Internet stocks and talk to companies, the outlook is less bullish. I wrote up my thoughts about the state of the internet sector on my way home from the Goldman conference; here they are, in the form of a checklist for investing in internet companies:
1. How engaged are a company's users, and how much are they really worth? The decline of Facebook (NASDAQ:FB), Groupon (NASDAQ:GRPN), Yelp (NYSE:YELP) and Zynga's (NASDAQ:ZNGA) stocks has been a wake-up call for many investors. It's not just a valuation issue. Those stock prices are telling you that monetization and sustainable growth in engaged users are more serious challenges than investors previously assumed. So investors in internet companies are now asking two questions: (1) How robust is the company's relationship with its users? (2) How well can the company monetize those relationships? The public and private companies that have great answers to those questions will do well; the others will struggle.
2. How real is the company's mobile opportunity? Everyone knows that mobile usage is exploding, but there are three serious challenges in mobile: (1) Many companies aren't seeing growth in daily mobile users. It's hard to get people to download your app, and even harder to get them to use it regularly once they've downloaded it. The root cause of the problem is the walled-in world that Apple created with apps. You can't link to content inside apps, you can't search inside apps, and many apps try to keep you inside their walled garden, even when you open a web page. The result is that app discovery is far harder, and occasional usage driven by links doesn't exist for apps in the same way it does on the web. So the outcome for many mobile companies is binary -- you use my app every day, or not at all. (2) Monetization is harder with mobile than the web. The best apps enable users to do just one thing, whereas monetization is often based on offering users the ability to consider something other than what they are trying to do right now. (3) A single app often isn't enough to build a company. Non-mobile websites enabled companies to deepen their relationships with users by cross selling additional services, products or functionality. With mobile apps and mobile websites, that's much harder.
3. Will the company continue to benefit from social sharing? Without discovery and occasional traffic from web links, many apps rely on social sharing. (Many non-mobile web businesses have also built their traffic strategy on social sharing.) But reliance on social networks has run into two problems. First, Facebook (FB), Twitter and LinkedIn (NYSE:LNKD) are under intense pressure to justify their valuations with increased monetization. Inevitably, increased monetization means more attention for whoever is paying and less attention for everyone else. Second, it's now becoming clear that as social networks' approach saturation, winning attention from their users is a zero sum game. The attention you get from someone who follows you on Twitter is roughly the time they spend on Twitter divided by the number of people they follow. In their push for growth via network effects, Facebook, Twitter and LinkedIn encourage their users to friend/follow/connect with as many people as possible, but that actually results in weaker relationships and less attention per friend/follower/connection. The social networks have done a great job convincing individuals that the number of friends/followers/connections you have is a barometer of your influence, but companies measuring actual visits know that real engagement with updates or tweets is often tiny.
4. Is the company providing real metrics? Since many companies are finding it difficult to grow the number of engaged users they have (due to difficulties with mobile and social sharing) and to monetize their free services, it's more important than ever that investors are provided with metrics to assess how internet companies are really doing. But many internet companies provide operating metrics which tell investors too little about the depth of their user relationships and the potential for monetization, and don't allow for comparisons with other companies. The number of monthly "check ins" for Foursquare, for example, is almost impossible to interpret, and has no parallel in other companies. In contrast, a useful metric that allows for cross-company comparisons is average *daily* users. Unlike monthly unique users, average daily users strongly reflects user loyalty and engagement. But few companies report that number. Some internet investors are therefore focusing on paying subscribers. If a user pays, you know the relationship is real.
5. Is the company tone deaf to privacy issues? The ability to collect data about users can be great for companies and great for their users, because products, services and advertising can be accurately personalized for each user. Smartphones have massively increased the amount of collectible data about individuals, because individuals are uniquely identified by their phones, and phones know your location. However, while the collection of lots of data about you may lead to great personalization, it threatens your privacy. The key issues are: How much data is gathered about you? And who is that data shared with? Recently, Quora changed its default settings so that your followers on its site could see what questions you're reading. (Imagine seeing that a friend is reading "How to tell your spouse you have cancer".) Similarly, at the Goldman private Internet company conference, the CEO of Foursquare said that a future version of his app would track and record where you go, even without you "checking in" -- and sell that data to marketers. At some point, the tension between big data and privacy will blow up.