The Market Risk in Irrational Exuberance for Social Media

Includes: AABA, GOOG, MSFT
by: Richard Bloch

After LinkedIn’s (LNKD) IPO, it seems as if a whole bunch of new companies (Groupon for one) will soon be scheduling their own offerings to take advantage of investor interest in businesses that capitalize on social media.

Another tech bubble in the works? Hard to say for sure. For one thing, it’s not so easy to recognize one in advance. And for some bubbles, you can pin at least some of the blame on excess leverage (the recent housing bubble, the late 1920s stock market, etc.). But where leverage isn’t much of an issue, there’s usually some promise or premise that investors embrace, and it may not seem all that irrational early on. Land in Florida? Tulips? South Sea ventures? There must have been some logic other than greed behind the origins of those bubbles.

I happened to be doing a lot of work in the technology sector in the late 1990s, so I had a pretty good view of the premises that seemed believable at the time, but obviously failed to materialize; at least in most cases. This article certainly doesn't sum up the whole dot-com bubble, just some observations from some of the conferences and meetings I attended way back when.

Dot-Com Bubble 1.0: Eyeballs, portals, and burn rates

For some companies in the 1990s, one word summed it up – “eyeballs” The logic? The more people who viewed your site, the more likely it was that you could “monetize” those eyeballs. I guess for some popular sites, a well-placed banner ad could bring in a lot of money on a per-eyeball basis. Until you ramped up, that is. Then you might find that the marginal additional eyeballs weren’t going to click your ad, making that ad a whole lot less valuable.

Remember, this was before Google (NASDAQ:GOOG) (and before it) introduced the bidding-oriented pay-per-click model. Before that, internet advertising was driven by banner ads, which were priced on viewership, not clicks. Eventually, (and it didn’t take long) users learned to totally ignore them, sending ad rates plummeting.

Some of the companies I remember working with were obsessed with establishing portals. These were sites that would be your online starting point, featuring directories of places to surf the net. Most offered search capabilities, but I’d venture that in those days more web traffic came from directory listings and less through actual search.

So one could have easily envisioned a world where a site like Yahoo! (YHOO) would be exceedingly valuable just because of the eyeball factor, if nothing else.

But another phrase, 'burn rate', entered the lexicon -- and that probably marked the turning point of a promising premise gone bad. Companies went public with no revenues at all. Their mantra? Grow fast at whatever the cost because the big money would surely follow. Your burn rate was how fast you were going through your investors’ capital in chasing growth at the expense of revenue -- and some burned out really quickly.

Today’s premise: Your connections and data

Ironically, the one company that began thriving after the dot-com collapse was Google. Yet today, the company is facing formidable challenges from companies with another premise – social media and networking. The search engine becomes a lot less relevant when search begins in a social context, among your friends, connections, those you “like,” and those that “like” you.

Former Google CEO Eric Schmidt even admitted it, saying he “screwed up” in not recognizing the impact of social media early on.

Today it appears as if LinkedIn, Facebook and other companies are banking on the premise that our willingness to make our connections public is valuable because they can mine for data on our individual interests, location, friends, purchases, activities, groups and much more. And company's can use that information to generate profitable returns.

The companies that are planning IPOs today seem to fall into this social media space. That's not the entire technology landscape, of course. In the 1990s, mobile devices, cloud-based data and applications, broadband services, content management platforms and other technologies barely existed. And to a great extent, they don't really have much to do with social media.

But the dot-com bubble in the 1990s didn't seem to have all that much to do with PCs, semiconductors, or routers. Yet stocks like Dell (NASDAQ:DELL), Intel (NASDAQ:INTC), HP (NYSE:HPQ), Cisco (NASDAQ:CSCO) and others got pummeled. Their valuations probably got way too high, of course, and deserved the beating they got.

So social media? It seems like a logical enough premise -- for now. I just hope any irrational exuberance this time around doesn't take the whole tech sector, and the broad market, down with it.

Disclosure: I am long INTC, CSCO, HPQ.

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