Posted by: mcgratha | January 31, 2011

Social Media company valuations – am I missing something?

A lot has been written recently in both the press and blogosphere about the huge market valuations being touted for the new wave of social media companies. This has led to inevitable comparisons to the dotcom crash back in 2000-2001. From my perspective, although I can appreciate the tremendous value and opportunities that many of these social media companies offer, I find it hard to reconcile this against their incredulous valuations.

Am I missing something that would explain how these companies are being valued so highly? I am not a financial analyst, far from it, but from my outside perspective, it just feels wrong.

Let’s look (see diagram below) at the valuations being given to some of the key social media companies in the market and consider these in comparison to other well known and established companies.

Market valuations
What is apparent is the scale of the valuation of these social media companies, given that they have all only been in existence for a short number of years. For example, Facebook’s valuation of $50B is bigger than Aviva, on a par with Tesco and close to Barclays.

Looking at the revenue numbers for these social media companies, it is clear that their valuations are based on a figure that is many, many times their revenue. See table below.

Valuation times Revenue
To put this into perspective, both Apple and Microsoft have market evaluations roughly 4 times revenue. Google’s valuation is about 7 times revenue and Tesco is actually about 0.6 times revenue. The profits from many of these social media companies are also very low, especially when compared to their valuations.

Unlike the dotcom crash of 2000-2001, the social media companies discussed in this post are significantly more advanced than most of their failed counterparts in 2000-2001 – they have an established and very large customer base, and they are turning over a profit with lots of scope to grow. Nevertheless, their very high valuations would seem to be based on notional expectations of future growth and profit … unless I am missing something? It is not clear whether their existing user numbers and engagement will translate into a sustainable and longer term business model (that matches up against their valuation).

The barrier to entry in this market is low, especially with new cloud computing models that will allow companies to grow their business by ramping up computing capacity very quickly, aligned with customer demand, and only paying for what they use. For example, a few years ago we never heard of Groupon and now they are being valued at $15B, having turned acquisition offers down from both Yahoo and Google for $3B (Oct ’10) and $6B (Nov ’10) respectfully. New competitors can emerge very quickly in this market which could easily make a significant dent into the valuations discussed in this post.

Perhaps I am more sceptical than I should be. However, during the dotcom I worked for marchFIRST which went from zero to 10,000 employees back to zero in just over one year.

If something seems too good to be true …

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Responses

  1. Well observed, and I share your scepticism. I’m no analyst either, but I think that this chart reflects the *desirability* of companies for being acquired, rather than their true value. It’s their potential they are trading on, not their current capital. (going back to your physics days… think acceleration vs. speed). Nobody is particularly likely to try and buy Barclays at the moment (or any other bank…). The contact list and customer profiles of Facebook or Amazon on the other hand are potentially worth marketing billions. In the chart above, the ones that surprised me most are: Apple vs. GlaxoSmithKline (really? are we that much more interested in gadgets than cures?) and how relatively low LinkedIn is (the world’s biggest job skills catalogue!).
    George

  2. Thanks for your comments George, very good points.

    From watching videos on http://www.ted.com I picked up the tip of when visualising stats on a particular subject, show them in context of something that most people will be familiar with, giving a better perspective to the stats. In this case, visualising how Facebook looks in comparison to other non-social media companies … which you picked up on with your comments on Apple and GSK.

    Regards,

    Adrian

  3. I know and believe in simple logic. You are worth what someone is willing to pay for. We all know what took facebook closee to 50B, offer from various giants to buy them. Do you think the bubble will burst as soon as these companies float on the market?

  4. Hi Vikram,

    Don’t think the bubble will burst, more deflate, and possibly quite a lot. Ultimately, you’ve got to make a net profit from your returns … quite a considerable task to achieve from a $50B investment in a market where competitor’s cost of entry is lower than ever.

    Cheers,

    Adrian

  5. Sure Adrian, I can agree to that.

  6. UPDATE: The valuations of some of these companies keep going up:
    * Groupon – Bloomberg is reporting that Groupon is in talks with bankers and could IPO with a valuation as high as $25 billion;
    * Facebook – Facebook has jumped in value from $50 billion to $65 billion, based on a new investment stake from General Atlantic
    * Zynga: Zynga is in talks with potential investors about raising around $250 million in new funding, which could value the company between $7 billion and $9 billion
    * Twitter – According to the Wall Street Journal, Facebook and Google executives have engaged in “low-level talks” with Twitter, estimating the value of the microblogging service about $8 billion to $10 billion

    Interesting article on Mashable about Warren Buffett warning investors that valuations for social media firms are unwarranted – see http://mashable.com/2011/03/28/buffett-declares-social-media-valuations-overpriced/

  7. See video from Thomas Power (@thomaspower) on thoughts around the possibility of Facebook becoming a bank and offering financial services (both direct and peer to peer) to its millions of users!

    Seemingly the established banks are very worried about this as Facebook could potentially capture a very significant market share within a few years. In the UK, you are allowed own a bank account from 14 years old (I believe) but most banks don’t allow you to have internet access to your account until you are 18. You can imagine the enormous number of teenagers that might sign up to a Facebook bank account and get internet access to their money … and access to money using a user interface that they are familiar with … and once in a bank, more likely to stay, which means declining numbers in the mainstream banks.


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