JPMorgan Chase & Co. Digital Growth Fund Bets on Twitter

| About: JPMorgan Chase (JPM)

By Kerri Shannon

JPMorgan Chase & Co. (NYSE:JPM) may be making Twitter Inc. a main player in the bank's new Internet-focused fund, betting on the profit potential of the social media star.

JPMorgan's asset management unit will run the new Digital Growth Fund and has raised $1.22 billion so far, according to a U.S. Securities and Exchange Commission (SEC) filing last week. It plans to raise $1.3 billion total and hopes to get a 10% stake in Twitter, people familiar with the matter said Sunday. It plans to invest about a third of the total assets, or $450 million, in the online messaging site, valuing it at $4.5 billion.

The fund was established in February to invest in rapidly growing tech companies, most of which are privately held. It will have a maximum of 480 investors, and earn commission of at least $13 million.

It's not clear if the Digital Growth Fund will invest directly in Twitter or buy current investors' stakes with the company's consent.

The fund will also invest a significant portion in another digital media company, possibly online gaming site Zynga Game Network Inc. or communications service Skype.

A final third will be allocated to a group of smaller investment targets that could include coupon service LivingSocial or flash-sales site Gilt.

Twitter, created in 2006, has grown rapidly this year as social networking becomes more popular and the site has worked on generating revenue. It started running ads last April, including messages known as "promoted tweets," and has attracted major brands like The Coca-Cola Company (NYSE:KO) and Nike Inc. (NYSE:NKE). Internet research firm eMarketer expects Twitter to raise $150 million in ad revenue this year.

Twitter earned $45 million last year, and eMarketer predicts it will hit $250 million in 2012.

Twitter's escalating worth has been turning investors' heads in recent months. The company two months ago raised $200 million from a group of investors that included Kleiner Perkins Caufield & Byers. The investment valued the site at $3.7 billion - almost four times as much as the $1 billion valuation the company had in September 2009.

Now Twitter is valued at more than $4 billion and has been rumored to be in talks about a potential sale. Possible buyers include Facebook Inc. and Google Inc. (NASDAQ:GOOG).

JPMorgan's interest in the site is similar to Goldman Sachs Group Inc.'s (NYSE:GS) play for a Facebook stake earlier this year.

Goldman Sachs, along with Russian investment firm Digital Sky Technologies, invested $500 million in Facebook, valuing the social networking leader at $50 billion. The staggering amount led to some analysts worrying this exploding social media craze could actually be growing into a tech bubble.

Another Internet Bubble?

While social media sites like Twitter and Facebook are immensely popular, they need to make money to be worth these multi-billion dollar values.

Facebook is currently valued at around $52.3 billion on SharesPost, a secondary market, but some recent trades show a value as high as $84 billion, according to The New York Times. SharesPost trades value Twitter around $4.3 billion.

Now the smaller sites are seeing their valuations start to skyrocket. Zynga was valued at around $5 billion by private share sales three months ago, and is now trying to raise more capital with a valuation of $9 billion. Groupon is getting offers to go public at a $15 billion to $20 billion value, after rejecting Google's $6 billion buyout offer late last year.

Groupon expects revenue to double this year to $3.5 billion to $4 billion. Zynga is also predicting a 150% to 200% revenue jump from last year's $1 billion.

But some analysts are saying these higher valuations are creating a situation similar to the "dot com" bubble that burst in 2000. They question the ability of these companies to rake in billions of dollars in profits.

"Analysts estimate that Facebook could bring in as much as $2 billion in annual revenue. I beg to differ," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "Sure, Facebook has a lot of people trolling through its site, but the important question is how do they monetize that traffic? In other words, they face the same old dilemma salesmen have faced since the beginning of time: How do you convert the ‘tire-kickers' into buyers."

Some analysts caution investors to be careful when hunting for the "next Google" in the social media realm.

"In its first year public (2004), Google made $3.26 billion in revenue," Fitz-Gerald said. "But Google had valid, often user-driven sales opportunities. Google's advertising targets, through its search engine, at least, are often looking to be ‘sold' when they go to the site. Whereas, Facebook users don't want their chatting/gaming/posting time consumed by invasive or even passive salesmanship."

Any tech investments not only bank on companies being able to meet projected earnings, but also that their intended markets will continue to grow, and that rising competition won't eat away at expected profits.

The key to companies sustaining their initial success will be their business models. Many are still in the early stages of making money so the ability to beat out an increasing number of competitors and continue profiting is still being tested.

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