Social Media Bubble?

Bubbles. The one thing which places a cold shiver down every analysts back. The world is currently only in the midst of recovering from the largest property bubble of all time. Earlier this century we had the insane dot-com bubble. Both of those bubbles saw prices rise, without foundation to never before seen levels. Many argue that post dot-com, the market was not allowed to properly correct itself, which partly feed into the later sub-prime/ property fiasco. Further still, some could suggest that bubbles are intrinsically inter- twined.

One then has to ask where the next bubble lies. The problem with over valued assets, is that one doesn’t realise they are over valued until it’s just too late. Many right now are talking about the possible bubble in Australia, others are discussing the possibility of China crashing and the unforeseen effects this would have on the world economy. While, I accept both of this are likely, I believe the next bubble is already in motion. I suggest that bubble to be social media. (Yes, an extension to dot-com)

2 Days ago LinkedIn floated an IPO on the New York Stock Exchange. The shares priced at $45 rose to $122.70 on the first day of trading. This means the market cap is somewhere around $9 billion! Can anyone find foundation to a value that high for a firm that does so little? The professional networking site has few streams of revenue and offers premium services to users in order to bring in revenue. Most user’s would choose not to avail of these services. The firm claims that 38% of revenue comes from this stream. Is that even a sound business model? In the first 9 months of 2010 profit was a measly $10 million. Does this sound like a firm worth 9 billion? Worryingly the firm openly predicts it will make a loss in 2011 as it did in 2009.

The honest truth is that LinkedIn is grossly over valued. There is no way, such a firm could command such a value. My advice of all is that begin shorting and wait for the value to fall! However, the recent behaviour of the market is highly unsettling. Recently Microsoft paid an astounding $8.5 for Skype. The previous owners were more than delighted to be offloading it as they found it had no use to them. Why? Because Skype doesn’t being in any revenue! The previous owner was none other than Ebay. Why anyone in Ebay thought that Skype could enhance the online shopping business is beyond me. But from going to market irrationality to plan stupidity is paying $8.5 billion for it. In fact, I’m quite sure Ebay are laughing all the way to the bank with the fact they have made a profit on this transaction. The price paid by Microsoft is 32 times Skype’s operating profits. Surely Bill Gates didn’t take his medication when he signed off on this purchase?

For one to suggest that social media stocks are being way over priced, I don’t believe is unreasonable. However the key lesson of pricing, is what goes up- always goes down. An even bigger problem is that a company can only be valued at what someone is willing to pay for it. When Microsoft figures out that Skype doesn’t actually fit very well into their empire, who’s going to write a check for $8.5 billion to take it off their hands?

I guess one should remember “fool theory”… Bubbles continue as long as the fools can find greater fools to pay up for the overvalued asset. The bubbles will end only when the greater fool becomes the greatest fool who pays the top price for the overvalued asset and can no longer find another buyer to pay for it at a higher price.

We have had a tulip’s bubble, railway bubble, uranium bubble etc so why not a Social Media bubble? The one key characteristic of bubbles is that they are the height of popularity at that point in time. However, the global economy would rather not experience a market crash right now. We are barely getting through the current one!