Is Social Media The New Dot-Com Bubble?

| About: Microsoft Corporation (MSFT)

Thursday sure was an eventful day in the market: A day where common sense suggests loss yet the S&P 500 closed with a gain over 1%. The day started with jobless claims on the rise, unemployment in Greece reaching an unprecedented 22.6%, and according to CNBC Spain's credit rating being downgraded three notches to one level above "junk." Yet despite such an irrational day, in terms of performance, the one story that really caught my attention was Microsoft's (NASDAQ:MSFT) interest in Yammer, a potential acquisition that is definitely worthy of a Chris Carter "C'Mon Man!"

I must say, I really don't get this whole social media craze. It's getting to where 18 year old children who call themselves "entrepreneurs" are buying a domain, finding someone to code, and then selling the so called "company" for $1 billion. Take Facebook (NASDAQ:FB) for example, the company purchased Instagram for a billion dollars, a company with just 13 employees. Meanwhile, The New York Times Company (NYSE:NYT) is valued under $1 billion despite having over 7,000 employees and $2 billion in revenue, a comparison that CNBC identified as old -vs- new media.

The craze for social media companies is something I am incapable of understanding. The Wall Street Journal published an article in May and identified 20 start-up internet (private) companies with a valuation over $1 billion. Obviously, private investors are investing big money into these companies and doing so with the belief that the investment will pay off with massive valuations once the company goes public. In other words, it's all sunny days in silicon valley, as some get rich, others will lose, and overall we are creating the next dot-com bubble.

When we take a step back and look at the massive valuations of social media companies you have to wonder if we learned anything from the dot-com era. Sure, the situations aren't exactly the same, but still, they're pretty close. Just in case you don't remember, or weren't following the market during the crash (which is when I started following the market), it was a time when companies with very little, if any, in capital were being given bullish valuations based on the potential of the internet market rather than valuations based on fundamental data (sound familiar)? These companies were taking advantage of record low interest rates to create companies with business models that had potential yet lacked results (sound familiar)? And then once the business models were created, several large well-known established companies acquired the dot-coms for insane valuations that did not match the fundamentals of the dot-com company, in hopes of integrating and profiting from the internet platform (sound familiar)?

If you take a minute to look through the valuations of the publicly traded companies of the social media space you would find it hard to identify a valuation that makes sense. And if you take another minute to look at The Wall Street Journal's list of 20 start-up internet companies valued over a billion dollars then just maybe you can see the true insanity of how we are valuing these companies. Yet some of the largest most consistent companies of the last 20 years are starting to fall in some of the same traps and are apparently blind to the mindless valuations that are being created in Silicon Valley. To better explain take a look at some of the most infamous dot-com acquisitions back at the start of the new millennium.

Back in the late 90s there were several companies that felt the wrath of bad business decisions. In 1999 Mattel (NASDAQ:MAT) acquired The Learning Center for $3.5 billion and then sold it one year later for $27.3 million. This is somewhat similar to the expected loss of JPMorgan (NYSE:JPM) that had investors so irate, the only difference is that Mattel was not one of the top five most profitable companies in the market. Yahoo (YHOO) was one of the companies that invested most heavily into the dot-com era, purchasing Geocities for over $3.5 billion and then buying for nearly $6 billion, therefore making the Dallas Mavericks owner Mark Cuban an instant billionaire. Unfortunately you can't find either of the two companies anywhere on the internet, therefore Yahoo's near $10 billion purchases became more like charity than investments. As a result some argue that Yahoo is still yet to recover from its bad business decisions, seeing as how its stock fell from $108 to around $4 in less than two years after these two high profile purchases.

One of the reasons I think history could repeat itself is because large smart corporations are getting suckered in to the "potential" of these dot-coms. In 1999 both Corning (NYSE:GLW) and Cisco (NASDAQ:CSCO) restructured much of their business to support a changing technology environment, the internet. Both stocks reached new highs, with GLW reaching a price over $110 and Cisco becoming one of the largest valued companies in the world. Yet because of both companies overly optimistic actions in an unproven market, Cisco lost nearly 90% of its value and Corning went from a stock price of $110 to just $2 per share, in less than two years.

The social media space is no doubt overvalued, yet the bull will argue that the internet is shifting to where marketing, advertising, and retail success will be measured on a social media platform and will depend upon the number of users on a particular platform. However, at this point it is still speculative, and trading with valuations that can not be logically explained, somewhat like a biotechnology company without any sales and a $10 billion valuation, think Dendreon (NASDAQ:DNDN) prior to its approval. And then for a publicly traded, overvalued, social media company to be acquired it requires an even larger premium, one that is almost certain to never benefit the company that is making the purchase.

For example, Google (NASDAQ:GOOG) is showing interest in purchasing Twitter. Some believe this would be a great acquisition for Google, and if the company is going to pay a high premium for a social media company then I honestly prefer it to be Twitter. Google supposedly made an offer to acquire Twitter last year for $10 billion, and Twitter refused. Yet recent rumors suggest Google is now prepared to make a new offer and Twitter is ready to listen. However, what price will Google have to pay for Twitter, especially considering that it's one of only a few succeeding in the mobile space, could it exceed $15 billion? And is it reasonable to pay such a large premium for a company that isn't expected to return $1 billion in sales for another two years? The numbers don't add up, but then again, these people are a lot smarter than me, and may see a diamond in the rough when all I see is an overvalued website that could become a fad.

At this point it seems as though we are making the same mistakes, yet expecting a different result. These companies are simply too expensive, yet the technology companies believe these companies are necessary to grow. In all fairness the valuations aren't as ridiculous as back in the dot-com era, although close.

My question moving forward is how will these high priced acquisitions affect large technology companies in the next two years? Facebook is in a no win situation because it has to grow through acquisitions and the only acquisitions it can make, short-term, are in the overvalued social media space.

However, for a company such as Microsoft I don't see the purpose. And although $1 billion is nothing to a company such as Microsoft I still hate to see them go this route and aid in repeating the next dot-com bubble burst. Instead, if I were on the board at Microsoft, I would vote to wait this out and let this fad pass, because with valuations this high, there will no doubt come a day when the bubble bursts and companies can either carry the burden of bad investments or grow and stand strong while its competitors fall.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: This material is for informational purposes only and should not be used for any investment decisions

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