social media stocks: #morepaincoming

Like many, I am surprised (and somewhat dismayed) by the popularity of social media. Personally, I have made some valuable connections on Twitter. But for the majority of people who habitually log in to social media platforms, I fear time spent on the sites is time wasted. And while all social media companies tout glowing statistics about the rapid growth of their user bases, I remain skeptical about the real social value—and commercial viability—of their products.

As I’ve written before, these are only marginally “tech” companies, in terms of the actual technologies behind them. A couple of kids in a dorm room can create a new social media platform in a matter of hours. In other words, barriers to entry in the sector are almost nonexistent, which means even dominant players will be plagued by constant competition, often from well-funded sources. (Both Facebook and Google now offer local business ratings comparable to Yelp, for instance.)  In terms of revenue generation, social media companies are primarily advertising sales outfits. That is a pedestrian business model at best and a downright shoddy one at worst. Who has the time to spend hours a day consuming (and generating) the content on these sites? Not the busy, affluent demographics advertisers will pay top dollar to reach.

As a group, the social media “industry,” loosely defined, reminds me of late-1990s dotcom startups. Its financial models are just as suspect. People seem to assume that user growth will continue to balloon indefinitely. But I believe the opposite is true. Finding and retaining new users will become more—not less—expensive and early adopters will likely spend less—not more—time logged in as new sites proliferate. Think about the evolution of television. Like social media, TV can be entertaining and informative, but—also like social media—it is primarily a vast wasteland of empty pop culture garbage and dumb, politically correct celebrities babbling about their aberrant lifestyles. When there were only three major networks and a few independent channels, each player enjoyed a large viewing audience. Now that there are hundreds of channels to choose from and fierce competition from new platforms like Netflix and Amazon, it’s a hell of a lot harder to make significant profits.

Year-to-date, social media stocks have underperformed. Yelp is down 60 percent, Twitter 18 percent, and LinkedIn 15 percent. Both Angie’s List and Spark Networks have dropped 6 percent. (Facebook is 2015’s big winner; it’s up 19 percent.) Despite this selloff, most social media stocks still have huge valuations: Facebook sells for 15x 2015 revenues and 24x ebitda, Twitter for 9x revenues and 38x ebitda, Yelp for 3x revenues and 22x ebitda, and LinkedIn for 8x revenues and 37x ebitda.

Twitter’s stock rebounded somewhat this week on news that it will lay off 8 percent of its workforce. I am perplexed by this. Why are investors so desperate to treat everything like good news for this company? Put it this way, in my 30-year investment career I have never seen a massively valued, “going and blowing” technology company suddenly fire nearly ten percent of its employees.

When growth slows in the technology world, it can do so quite quickly. Because advertising constitutes the lion’s share of social media revenues, changing perception by advertisers—not users—could cause them to cut back abruptly on this spending. As also occurs in hot technology sectors, buyout rumors tend to surface as stocks decline. But even if Google or another behemoth swoops in and acquires one of these fallen angels, I suspect that the sector could see more pain ahead. As the industry matures and advertisers increasingly question how much bang for their buck they’re really getting from these companies, their stocks might have a lot further to fall. In short: buyer beware.


2 thoughts on “social media stocks: #morepaincoming

  1. Tim

    At the time of FB’s IPO, I tried to figure out what could possibly make it (and similar ones) valuable… because, granted, there is almost no social value there, other than helping already mostly lost people waste even more of their time… I decided that, in addition to capitalized cashflow, as traditional valuation calls for, FB, TWTR, and to a lesser degree LNKD, have option value embedded. I think owning them is somewhat akin to owning a parcel of land next to a highway in a new community… Although pretty useless and undeveloped currently, chances are someone will eventually decide to build good old cash-generating real estate on it, and you’ll get to participate in the upside, through either sale or lease…

    I think all the talk about trying to value social network companies based on cashflow, is just rationalization by the sell-side of this vague but certain gut feeling of embedded optionality.

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