The Coming Social Network Bomb

Includes: GOOG, LNKD
by: Dana Blankenhorn

I've covered many booms and many busts in 35 years as a business writer. And now comes the Soc Bomb, the social networking bomb. As with the Internet Bubble and Dot Bomb of a decade ago, there is value in social networking. Sites like Facebook, Twitter, LivingSocial, Yelp, LinkedIn (NYSE:LNKD), Groupon and all the rest help draw customers down the sales funnel. Most have found ways to monetize this process. Business has gotten done.

But how much business? How much is that business worth? And what are the costs of doing that business? When Soc Bubble supporters gather, they usually say that Google's (NASDAQ:GOOG) got a problem, as former CEO Eric Schmidt noted recently, because it missed this boom just as Microsoft (NASDAQ:MSFT) missed the Internet bubble.

But the situations are not analogous because there are two sides to social networking, revenues and costs. Google has the lowest costs serving Internet stuff in the industry. It owns its own fiber. It's pioneered methods for saving on hardware costs by using standard PCs, on software costs through open source, on energy costs by opening windows, and on moving data with “Google in a Box,” a system that can go to a phone network Point of Presence and keep 90% of its traffic from ever leaving town.

The problem for Google is on the revenue side. What Groupon does drives people further down the sales funnel to a purchase than any advertisement Google can put up. Linkedin can create more valuable buzz for a company than any comparable Google service, and do it faster.

I get that. But the reported valuations for these things are crazy. Facebook isn't worth $50 billion. Groupon isn't worth $15 billion. No matter what their revenue potential, they haven't solved their cost issues, and they're as easy to compete with as a sock puppet.

What makes this cycle fun is who is going to be burned by it. Private equity has taken the run-up past all reason, and it won't be able to get out in time. The “Time Buys AOL” moment in all this is in process, with LinkedIn's IPO and the Groupon S-1, filed yesterday.

Give investment bankers credit. They're not idiots. By selling just 20% of LinkedIn for $660 million, the banksters engineered a pop from their initial valuation that drew in traders and dumb money. But that's already fading.

Groupon will try the same thing, selling “just” $750 million in equity, then implying a huge valuation for the whole. Some investors will think they are buying gold and find it's really pyrite. It's when other social networks try to run the same scam that the market will quickly saturate, or when owners of the remaining shares think they can get the same valuation the banksters engineered that things will tank.

That's the silver lining, it seems to me. Seeking Alpha covers public companies, not private equity markets. Readers here are going to be shielded from the immediate economic fallout. The smart, the rich, the well-connected are going to find those connections aren't worth the bits it took to download them.

At the end of the day, there will be value here that can be monetized. Driving people toward a purchase is more important to anyone selling anything than just driving them into the sales funnel, which is all an ad can do. At some point, costs will come into play and those ISPs which, like Google, have paid attention to costs will find they can get some bargains.

You will still be hurt. Rich people don't like playing in rigged casinos. They don't like having to raise equity to pay back bad bets. Stuff that should be rising will be falling until this mess is cleared out.

I just pray the wealthy suckers taken in by the Soc Bomb know who to blame when the dust settles.

Disclosure: I am long GOOG.

Additional disclosure: My retirement account owns 20 shares of Google, bought a few months ago.