The internet appears to be the one of the greatest enablers for innovation in our generation. When paired with mobile devices, the unleashed world remains just a finger tip's distance away at any given time. With billions of users posing as potential consumers, the mystique of the Internet's economic depth and potential represents a seemingly unquantifiable market open for the taking.
Yet with great promise lies the hype behind speculation. So great was the appeal of the Internet investment phenomenon at the end of the last millennium, that the fall of expectations back to reality caused its own general market crash according to the event that has since been known as the "Dot Com" bubble. As online companies once again begin to show share prices that exceed normalized multiples, there remains in itself the question of whether or not investing in internet growth companies offers anything more than a fair gamble.
Three distinct characteristics tend to plague the market these companies operate in. From the standpoint of an investor, these attributes can keep such companies from serving as ideal investments when it comes to long-term sustainability:
- Popularity. Internet companies that reach that point of being a publicly traded entity often entail a user following that defines the prominence of the company itself. While allowing for accelerated growth, this can result in two less desirable effects which comes in the form of increased volatility and increased hype. Popularity can be quick to shine and quick to fade, and hype can keep share prices inflated well beyond a rationale valuation. Neither are good in an open market environment overextended time periods.
- Saturation. Due to the ever growing face of the Internet, one of the few problems this industry encounters is getting crowded out by the vast amount of competition in a similar space. While many public internet companies now have defined niches, a good number are still reliant on advertising revenues which may continue to be spread out thinly as the functions of the Internet trend accordingly. Ongoing innovation and marketing can also be costly affairs when it comes to sustaining leadership.
- Low Barriers to Entry. Much in line with the concept of saturation, the ability to enter into a market space is hardly restrictive. One programmer and a computer is often all that is needed to plant to the seed to the next big online concept. Add in factors such as cheap labor overseas and a vast amount of companies willing to clone successful models, and the Internet is a far from safe environment to be able to monopolize a particular corner of its economy.
The upcoming initial public offering of Facebook (FB) offers a glimpse of popularity in motion. While undoubtedly Facebook operates a model of success, one wonders if the hype the company embraces (and which will undoubtedly be reflected in its share price) will result in expectations that surpass reason. In another article located here, I argue that market pricing uncertainty has done little to help provide a good reason to invest in social media companies. As it stands, companies like Groupon (GRPN) and Zynga (ZNGA) have since taken significant haircuts to their valuations as the market itself began to question what it was investing in.
When it comes to market saturation, one wonders if companies like Angie's List (ANGI) and Yelp (YELP) have what it takes to carve outlasting empires in the consumer review space. Yelp must surely be eying Google (GOOG) with some concern as the search engine giant acquired Zagat in late 2011 - a move that is undoubtedly geared at chasing Yelp's bread and butter restaurant review platform. Likewise, Angie's List continues to market heavily at a loss and actually loses more value the harder it tries. While seemingly being far from anything greater than a glorified listing board, Angie's List's latest maneuver to allow insiders a way to sell out comes with the apparent intention to prevent a market shock on the share price.
Last of all, low barriers of entry have provided ample opportunity for competition in foreign countries to build up a presence of their own based on duplicated business plans of success. Chinese companies such as Renren (RENN) and Dangdang (DANG) have no shame in cloning American ingenuity with their copies of models such as Facebook and Amazon respectively. As well, the ability for new companies to emerge seemingly out of nowhere also requires an active radar for future threats. A company like Pinterest should remind investors that Facebook's dominance on the social realm necessitates ongoing innovation if it's to stay competitive to the "next big thing."
With all things considered, investors should therefore take note that while public Internet growth companies offer amazing opportunities, they often survive in a fast-paced environment where the glamor can fade as fast as it's appeared. This is not to say that great investments can't be found, but it is to assert that the future may not be clearly defined or that the stock will even be at an ideal price once discovered.
Investors truly interested in sustainable growth should therefore look to companies that can have lasting impacts in the real world economy. Take for instance a company like Solazyme (SZYM) with its value-enhancing oil replacement technology platform. Though currently sporting a mere $40 million in revenue, Solazyme is on pace to do over $600 million by year-end 2014. Such meaningful growth serves as a reminder that opportunities can exist outside of the Internet where attractive measures like "triple digit user growth" are often used as an enticing expression of future potential. In the end, investors often just need to broaden their perspective of the market's opportunities rather than resorting to the companies they've come to use daily and believe they understand.