Many of us who have experienced the Internet bubble at the turn of the century are concerned about billions of dollars of current valuation of the social media companies like Facebook, Twitter, and LinkedIn. Yesterday WSJ reported that JP Morgan is planning a fund to invest in social media companies. Although JP Morgan has not yet provided any details, blogosphere is abuzz with analysis of the situation. Many reputed financial bloggers have equated social media valuation with the Internet bubble. See for example, here and here.
I think that there are some important differences between the valuation of the Internet firms and the social media firms. For example, unlike social media firms, most of the dotcom firms didn’t have any business model or revenues. The average life of these firms was less than 3 years (citation needed). Even then I am not ruling out overvaluation of social media companies outright. The question is “Is the over valuation of social media firms comparable to the Dot.com firms?” It seems that many agree on a “No.” Here is a nice post about the Facebook revenue model and the way they are expanding. It is critical to realize that Facebook is a platform for so many things such as advertising, ecommerce, etc. Interestingly, Felix Salmon jumped into the fray to defend the valuation of Twitter!
It seems that the people who are criticizing the valuation don’t even know these businesses well. For example, Duff McDonald argues that there is no reason for people to pay for ad-free Pandora because they never have to see the ads. However, as one commenter pointed out, this is not the case! The commenter says –
Ads on Pandora are mostly audio ads. They may have some on their site, but you’ll hear audio ads in between songs in the standard version. There’s definitely a case to be made for paying a few extra bucks to avoid those ads.
Felix Salmon also points that fixating on value to revenue ratio is wrong since the revenue is currently being generated only from one part of the business. It is possible that the growth of revenue may not be huge in that part but as more revenue streams are tapped, the valuation might be justified.
It is possible that the businesses that are going to generate all the money only from advertising (a la Google) may find the growth flattening. Even though the US social media ad spending is increasing fast, it is still tiny at around $2-3 billion per year. It is therefore difficult to believe that only the ad revenue will lead to these huge valuations.