Social media investment bubble has popped

Atlanta, GA 5/22/12 (StreetBeat) – That fizzing sound you just heard coming from Wall Street in the wake of the Facebook Inc. (Nasdaq: FB) initial public offering was the sound of a bubble deflating.

You may have missed it due to the angry shouts of those who have lost big money on the most-hyped stock offering in history, even as Chief Executive Mark Zuckerberg and other insiders are laughing all the way to the bank.

Now that frothy air is accelerating out of the valuations of Internet social media companies, those investors who got in late to the party are worried how bad things might get. Many are selling first and asking questions later.

If you own shares of mutual funds focused on tech or growth stocks, those investors likely include you, unfortunately, since it was institutional money managers who were left holding the bag on Facebook. If you don’t own those funds, pat yourself on the back for avoiding the disappointment that social media investing has produced in 2012.

These stocks are now officially in correction mode.

As of this writing, in the last six trading days, $14 billion has been erased from the combined market caps of Facebook (Nasdaq: FB) , Zynga Inc. (Nasdaq: ZNGA +2.12%), LinkedIn Corp. (NYSE: LNKD +8.47%), Groupon Inc. (Nasdaq: GRPN -1.53%) and Yelp Inc. (NYSE: YELP -1.25%). That’s a 10.4% drop for the sector, which as of Tuesday was valued at $120 billion in aggregate.

Before this month, the sector had mostly tread water as big gains in LinkedIn offset losses in Zynga and Groupon.

Regular readers of this column will remember that last August, I suggested that the value of Groupon had peaked, after the company’s amended regulatory filings showed that its losses were widening despite a 10-fold jump in revenue.

That column came the month after Marc Andreessen, the new rising star of Silicon Valley venture capitalists, said of tech-company valuations: “On a 30-year basis, these things are cheap.”

But few investors have a three-decade time horizon, and the meaning of the word “cheap” isn’t the same for VCs — who get their shares in private transactions — as it is for investors who pay retail stock prices.

Private investors poured $1.4 billion into Internet companies in the first quarter of 2012, according to the National Venture Capital Association. It was the eighth straight quarter that Web startups garnered more than $1 billion, which means Andreessen is far from alone in his bullish assessment.

But with Facebook and the other young Internet companies now all failing to find firm bids in the public markets, it’s just a matter of time before the froth starts to come out of the valuations of private Internet companies as well.

The questions now are: Will the correction become a full-blown bear market? And how much will the social media bubble look like the dot-com bubble?

Fear and greed

As with other bubbles — from tulips to dot-coms — the social media boom was created by greed and inflated by fear.

The greed that started this bubble came from those in the private investment community who — by design, of course — are out to maximize profits. People invest money to make money, after all, so it’s no surprise that VC firms have rushed in to fund so many social media startups.

The fear that inflated it emanated from professional money managers who were terrified of missing out on the “hot” IPOs of the past 12 months; that fear is ironic when you consider these fund managers are, for the most part, playing with other people’s money — in millions of brokerage and retirement accounts — and thus have no real skin in the game.

Now that the VC-fed bubble in social media stocks has met the sharp anger of all those money managers counting up their Facebook losses, look for the public markets to start picking winners and losers in the social media industry. The rising tide that has lifted all social media boats is clearly ebbing.

Companies that can’t produce annual net income despite billions of dollars in annual sales — including Groupon and Zynga — are going to end up as also-rans or takeover fodder at valuations well below their current prices. But don’t grieve for their insiders, who cashed out big even before their disastrous IPOs.

At the same time, there’s a reasonable chance that Facebook and LinkedIn will survive as public companies — given that every new technology market produces two or three winners. (For example, think Intel and AMD in chips; Dell, H-P and Apple in PCs; Oracle, IBM and Microsoft in enterprise software; or Google and Amazon.com in Internet services.)

P/E watch

But it will take both Facebook and LinkedIn a long time to grow into their current valuations.

Based on Tuesday’s closing share price of $34.03 a share, Facebook is trading at about 65 times expected 2012 earnings of 52 cents a share, according to the consensus earnings estimates compiled by Thomson.

LinkedIn is even pricier. At a price of $96 a share, it’s trading at 143 times expected 2012 earnings of 67 cents a share.

Given that froth, even the best of the social media stocks might have much further to fall.

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