Twitter, Facebook Grossly Overvalued: 'Build Traffic and the Profits Will Come' Isn't True

If a short selling genie granted me two wishes, my first would be for Twitter or Facebook to IPO. My second would be for a mid-sized company like Yahoo (YHOO) to acquire Facebook . This way, I can finally take advantage of these companies' gross overvaluations.

Internet advertising is maturing. It is easy to target ads by location and context. There are no ‘monetization issues’ anymore for large sites. If your site is not making much money, it is because the traffic is not worth that much. End of story.

Unlike television, where you are sending out a message to millions of random people, internet advertising is highly personal….and in the internet world, all people are not created equal.

Some traffic is much, much more valuble than other traffic. Someone in North Carolina searching specifically for debt consolidation or a divorce lawyer? A firm in one of these industries will pay a hefty price for that lead since that sort of lead is very valuable to them and will likely convert into a paying customer.

This isn’t a theoretical debate. Internet traffic can be tracked 100% of the way. The law firm in the above example can track the clickthrough rate of the ad, the lead generation rate, and the amount of revenues derived from the ad. Thus, they can tell if the ad is making or losing them money. It’s truly capitalism at its best.

The effect of this so far on internet advertising rates? Someone searching for a high-margin service is worth literally 1000 times (at least) that of some random facebooker looking around profiles.

I see this phenomenon on websites. The more targeted and the better paying the niche means the traffic is worth more. Someone actively searching for say, relationship advice, is worth a lot more than someone in a relationship just browsing Facebook or some internet forum. Facebook would have you think otherwise, but they are deluding themselves.

Someone actively looking for relationship advice is more likely to buy a product to improve their relationship. Someone that happens to be in a relationship may be curious as to the ad, but is less likely to click, and even less likely to buy the product.

When a person is searching, you know what is on their mind. They spell out to you what sort of product they are looking for. If they are just browsing a friend’s Twitter or Facebook page, all they are doing is browsing. Even if you base ads on what the person gives you in his or her profile, let’s say they are a dog lover, there are only so many dog advertisements you can throw at someone. They may also not be looking for any dog-related products anytime soon.

You are guessing at what they want; they are not telling you. You are hoping they look at your ad; they are not actively looking for your product.

Ad blindness, in particular, is a major issue. It is well-known in the internet business that new visitors are worth more, much more, than returning visitors for an advertising-based site. Previous visitors are likely ad blind to the site. They are also less likely searching for something to buy through the site’s advertisements; they are more likely just reading for recreation.

If Twitter has not been able to monetize successfully by now, I doubt they will likely do so in the future. From what I can tell, Facebook is well monetized and their advertisers are likely grossly overpaying. This is just my personal speculation, but based on reports I have read, I would guess that Facebook’s CPM is around $.40 (or better), which is well over 5-10X what a website similar to Facebook would get. That’s a hefty premium, especially considering Facebook’s traffic is a bunch of ad-blind college kids mindlessly browsing the site. Facebook will always command a premium, it is after all a ‘cool,’ large website, but I doubt this sort of premium will continue for long.

It’s not 1999 anymore. If an internet company with a tremendous amount of traffic is not able to make money, it is because their expenses are too high and their business model is poor. The ‘build traffic and the profits will come’ is a good line to sell to technically-unsavvy investors throwing money after the latest fad, but it can only work so long, especially in this deleveraged environment.

I doubt Google (GOOG) will buy Twitter, and even if they do, the size of the acquisition is too small to matter to Google. Even if Twitter is truly worth zero and Google pays $1 billion for it, that is less than 1% of Google’s market cap. However, letting Yahoo gobble up Facebook for $5-$10 billion would be a great reason to short YHOO. It could well end up being Yahoo’s Vietnam War, or should I say AOL (owned by Time Warner (TWX)) acquisition.

Today’s tulip speculator is the person paying over 10X EBITDA for either of these sites. From what I can tell, their valuations well supercede this, even in the illiquid private market.

Disclosures: None.

Comments

[Kevin K2:]

(linkback) Believe or Doubt? Twitter, Facebook Grossly Overvalued [VOTE] - www.pikk.com/e8b27

Apr 08 06:50 AM

[wavelength:]

Great article Michael. Thanks. Could not agree more. As someone who makes their living through Google AdSense income, I have learned the hard way that not al traffic is created equal. In particular, the difference between the value of visitors who find me through organic search and those who find me through social networking/Web 2.0 is profound. My experience is that Facebook, MySpace, Stumbleupon etc traffic is pretty much worthless. Only targeted traffic is of value, and even then, only if the reader actually wants products or services.

Apr 08 09:45 AM

[Justin Cred...:]

Sorry, but the 1990's were totally different. Wall Street valued web sites based on network traffic. Not the case anymore. Google and Microsoft may do it, but why did we have a crash on the NASDAQ in 2000? Because everyone figured out that those websites(Yahoo, Pets.com, Web Van, the list goes on) did not make enough money to justify those ludicrous valuations(your dot com bomb). It's been 5 years for Facebook and still no IPO, I wonder why? Yahoo has 500+ million users, but is only worth 1/6th of Google's market cap. Go and look back at Yahoo's stock. It was never the same after the crash. Don't believe the hype, you need a solid business model if you wish to have a solid business.

On Apr 08 06:16 AM Cetin Hakimoglu wrote:

> Sorry, but Twitter and Facebook are far from being overvalued considering
> they dominate their respective niches and have huge growth and revenue
> potential. Facebook is like Yahoo in 1997 and twitter could revolutionize
> communications like email did in the mid 90s.

Apr 08 10:15 AM

[Justin Cred...:]

Great article Micheal. This has been the case since day one but the hype has blinded everyone.

Apr 08 10:17 AM

[Justin Cred...:]

Half a billion in startup funds($515 Million), yet they can't even make half the revenue of Myspace($700+ million)? Where is the viable business model? The growth is there no doubt. I remember Mark Zuckerberg said this thing would be bigger than Google. It would take Facebook years to match the annual revenue of Google(Facebook: 300 million, Google: 21 Billion). So I ask again, whats the business model? More display ads or virtual gifts? We can't compare it to pets.com, cool. Lets compare it to Friendster and Myspace, two social networking sites billed as the next big thing only to have their value reduced by a lack of growth in revenue, not traffic. Mark is the only CEO who can say the focus for a business is growth and not money. Could you picture Bill Gates saying such a thing?

On Apr 08 12:42 PM Cetin Hakimoglu wrote:

> Facebook's huge valuation is based off network traffic. I'm sure
> wall street would also value it accordingly. There is no comparison
> to pets.com and facebook or twitter in that the later actually has
> a viable business model and growth.

Apr 08 01:36 PM

[jtillman:]

You must have some vested interest in facebook to pump it up like this. There is no way a sane person would value facebook as a viable company in next 5 years. Unless facebook finds a business model it is not going to be able to support it self. Most of the recent growth has been coming from international market where the advertising money is not as much. An Indian user on facebook isn't as valuable as a US one. Don't forget that an ad costs 1/50 (due to currency difference) that of in US i.e. 1/50 of revenue. But the same user can potentially use as much bandwidth as a user in USA. This scenario is destructive even in case of good business model.


On Apr 08 01:40 PM Cetin Hakimoglu wrote:

> Facebook's options regarding monetization are seemingly unlimited.
> They have ample funding so the main priority is trying to accrue
> user and improve the user experience.
>
> On Apr 08 01:36 PM Justin Credible wrote:

Apr 08 09:58 PM

[DDate:]

I agree that both are way over valued. Another problem is that kids get tired of the same old sites and are always looking for the next big thing. If they don't make money in the next couple of years, they won't make money without big cuts in costs!

Apr 08 10:23 PM

[Crude Oil T...:]

These sites are actually under valued. Google can't run every company......social networking sites need to watch, learn and listen. The Google plan will work for all of them.......




crudeoiltrader.blogspo...

Apr 09 02:20 AM

[ExOut:]

Maturing? iNet advertising is mature. When I lived in Bushwick Bklyn in a Spanish neighborhood I would get Spanish-language ads delivered to me... and that was two years ago...

Apr 11 09:27 AM

[Lightway:]

Facebook = Geocities of the 1990s
Twitter = CB radio of the 1970s

Apr 18 05:14 AM