Facebook At $65B, Twitter $7.7B, Zynga $10B: Why Social Media Is A Bubble

San Francisco, California: Value and price are not the same things. Not in real life. Especially not on Wall Street. Social media as a viable business model may just not work.

Gary Wolf, in his book, Wired, points out two interesting apsects of tech bubbles. First, enthusiasm for the digital revolution (which will of course now read, social media revolution) makes huge speculative investments seem reasonable. Two, a bubble feeds upon skepticism. People who stoutly refuse to purchase shares for a few hundred, gladly do so for a thousand when they see others investing, and apparently becoming rich. Sound familiar?

Welcome to the tech bubble, where social media is the new dot com. Of course, it is not a bubble if high valuations can yield the returns, so there may be hope yet. Theoretically, that is. For all practical purposes, we have social media companies fetching billions and billions of dollars; and nothing yet that can justify such astronomical valuations.

Facebook valuation is a hyperbole

The company's valuation has been climbing since the beginning of the year, and according to latest reports the company has a $65B price tag. But was the company really worth $50B to begin with? Before you answer that question, lets get a perspective on some other companies that have a similar price tag.

Ford Motors (NYSE:F) for example. The 107-year old automaker was founded in 1903 by Henry Ford, and is the second largest automaker in the US, and fifth largest in the world. A look at the company's financials reveal that the company has assets worth $177.078B, 1,98,000 employees, and sales of $131.975B. Ford has a current market cap of 53.48B.

How about Boeing (NYSE:BA)? The Boeing Company is a major aerospace and defense corporation, founded in 1916. It is among the largest global aircraft manufacturers, and the third largest aerospace and defense contractor in the world. Boeing currently has a backlog of 850 orders, the largest pre-order in aviation history, incidentally. The company's stock has appreciated one hundred per cent over the last year or so. Boeing has a market cap of 52.20B.

Lets take a look at some numbers from Facebook now. The company is six years old. It is in the business of, ahem, giving people the power to share and making the world more open and connected (Facebook's words, not mine). While total revenue figures are not forthcoming, the company's ad revenues reportedly hovered around $1.86B for FY 2010, estimated to be about 5% of all online ad spend in 2010. Good; but good enough?

While Facebook technically owns the content on its site, it cannot reproduce any of it for revenues like a NBC or a HarperCollins. Facebook has over 500 miilion active users, half of who log in every day, says the company. That is a pretty big number. The users are however not locked in, and may switch loyalties. Remember how Gmail changed email forever, and a huge chunk of us switched to using Gmail as our primary email? Times change. In the technology ecoscape, time changes faster.

InformationWeek looks at a different metric to look at Facebook's valuation, and emerges sceptic. It seems Facebook generates a measly $4 of revenue per user, as opposed to Yahoo ($8 per user) and especially Google ($24 per user).

What about Twitter?

The company has 200 million accounts according to a recent email sent out to users by co-founders Biz Stone, Evan Williams, and Jack Dorsey. Twitter's valuation is believed to hover between $7B to $10B. Despite reports in the media, that Google and Facebook are separately in talks to bid for the company, so far Twitter has been denying the stories.

The company was valued at $1B in a round of funding just the year before. The latest numbers peg the price to at least eight times that.

How does this San Francisco-based 200-employee strong company make money? Through promoted tweets, and commercial accounts. The company has search deals with Microsoft and Google besides. Twitter also may or may not be working on a way to mine the vasts amount of social information it has at its servers.

Long story short, Twitter has a great product, an extremely loyal fan following, a very disruptive technology that has forever changed the way media works, with far-reaching socio-political implications; but no really good way to monetize the change it has brought about in the world.

The $10B virtual farm

According to a report in the Journal, Zynga is close to completing a funding round of $500 million, valuing the company at $10 billion. This funding is basically a curtain-raiser to its IPO, and involves big institutional investors like Morgan Stanley, T. Rowe Price and Fidelity Investments, along with Kleiner Perkins. DST, the same guys who own a stake in Facebook, are also investors in Zynga. Infact Facebook is one of the key driver's of the company's phenomenal growth.

Some of Zynga's games include Cafe World, Treasure Isle, Frontierville, Mafia Wars, and Petville, besides its two star properties FarmVille, and CityVille. According to the company fact sheet, it has over 215 million monthly active users. 50+ million users are active daily. Luckily for them, the farms are virtual, and therefore elastic!

Why social media may not be a sustainable business model

Social media companies are very young; and their business and revenue models are subsequently untested, and untried. Of course, they may prove to be very very successful in the long run. Then again, they might not.

-- Social media companies are mostly platform-based; that is they offer a platform for users to interact upon. The entire business model of social media companies is based on the premise that users will continue to use the platform, the platform will continue to be sufficiently engaging and sticky, and their first mover advantage will be a sufficient barrier to entry for new players in the same space.

Google has managed to diversify, and has significant brand extensions (some would argue to the point of losing its core focus); but for most social media companies, it is still just the platform, and the platform it is.

-- There is also the assumption that users will altruistically keep on generating content. Look at Yelp for example. It is a platform and an aggregator; but Yelp users are the ones doing all the legwork; you know, generating the actual content that keeps the site running. As the novelty factor wears off, a larger chunk of users may chose to be lurkers, and then who will generate the content, and what will the business be? (The 1% rule or the 90-9-1 principle is worth mentioning here. This principle reflects the participation inequality in the Internet world; where for every 100 users, it is believed one user creates content, nine edit or modify that content, and 90 view the content without contributing).

-- Markets will reach saturation. Again, going back to the Ford example, a person can have several cars during her lifetime; but only one Facebook (or insert your favorite social media company here) account.

-- Which also means, that at some stage, all social media companies will in essence have the same users. How will Facebook differentiate itself from say LinkedIn, if despite providing very different engagement platforms, they are engaging the same users at the end of the same day? The battle may boil down to a matter of margins and rate cuts and discounts, commoditizing the platforms, and we know from print and cable advertising today how that will work out.

-- There are no independent audit bureaus verifying the number of users social media websites say they have. Of the several hundred million active users; how many sign in every day? How long do they stay logged in? Of the amount of time they stay logged in; are they on that site, or working on a different browser window? LinkedIn's filings with SEC clearly underlines this challenge. "The number of our registered members is higher than the number of actual members, and a substantial majority of our page views are generated by a minority of our members," says the company. Go figure.

-- As users get more and more exposed to advertisements, they become more and more adept at scanning web pages and filtering out extraneous information, like ads. Advertisers are aware of this.

Sure, users also fast forward advertisements on TiVo. But while there may be a handful of cable companies battling for mindshare and advertisements, there are thousands of social media companies battling for the same advertisement dollars.

Too bad social media companies are not Disneyland

The closest approximation to social media companies in the offline world is perhaps Disneyland. Disneyland offers a theme-park (a platform, if you will) for users to engage and interact in. Disneyland also has several thousand users coming in every day. Besides the obvious differences between the two, Disneyland is making money; besides having million dollar subindustries. Facebook's subindustries are also making money. Facebook, not quite.

The wave of dot com companies that mushroomed in the 1990s, believed in the 'growth before profits principle'; where the assumption was that if a website could somehow accumulate a large user-base, profits will somehow follow. In the case of Google or Amazon or eBay it did. This time around, a large user-base is becoming a given; but profits are somehow not following.

Who is getting richer from the bubble? Mostly the rich.

According to a media release issued by SecondMarket, an online exchange for alternative investments, it has surpassed a half-billion dollars in completed transactions since the launch of its private company market in April 2009. Not only that, SecondMarket touched $100 million in private company transactions in FY2009. Plus, there was a four-fold increase in FY2010, with over $400 million in completed transactions. Sharespost, another similar online marketplace, boasts of $125B+ in capital. Companies featured in sharespost include Facebook, Twitter, LinkedIn, Zynga, Yelp, and Digg among others.

Online secondary markets may work a lot like eBay, but it is very picky about who can actually participate. Typically three categories of investors can get a buy in. Accredited investors, typically high net worth individuals whose net worth at the time of the purchase exceeds $1M; qualified purchasers, typically someone with over $5M in investments, and qualified institutional buyers, typically investment or insurance companies.

LinkedIn's IPO will be the first opportunity for the average Joe to invest in the bubble.