Finweek English Edition - - COVERSTORY - By Marc Ash­ton

There’s a mor­bid fas­ci­na­tion with the in­vest­ment mer­its for on­line so­cial net­works. How­ever, in­vestors need to tread care­fully be­fore they com­mit their hard-earned cash to one of those in­vest­ments. There’s no ques­tion there’s a mar­ket for such prod­ucts. Whether it is the in­fa­mous PigSpot­ter keep­ing South Africans safe from the Metro Po­lice on Twit­ter, stalk­ing a work col­league on Face­book or us­ing a tool such as LinkedIn for pro­fes­sional net­work­ing, the ap­pli­ca­tions are at­tract­ing thou­sands of eye­balls.

While on­line so­cial net­works are re­defin­ing the way peo­ple con­nect with one an­other these aren’t nec­es­sar­ily turn­ing into rev­enue. And while the ini­tial pub­lic of­fer­ings (IPOs) are at­tract­ing bil­lions of US dol­lars in cap­i­tal, you have to ask whether the in­san­ity can ac­tu­ally last.

“Just as was the case in the dot­com bub­ble, fi­nan­cial con­tor­tion is tak­ing place to help in­vestors find facts that fit the story,” warns Adrian Sav­ille, of Can­non As­set Man­agers and lec­turer at the Gor­don In­sti­tute of Busi­ness Science. Sav­ille adds that – just as with any other fi­nan­cial bub­ble – it’s only a mat­ter of time be­fore it bursts. He adds emerg­ing mar­kets – in­clud­ing South Africa, Rus­sia and China – haven’t been ex­empted from this “ex­cep­tional over­pric­ing”. In the case of Rus­sia he points to Yan­dex and in China he uses the ex­am­ple of Ren­Ren, which has been dubbed “the Face­book of China”.

As the at­tached ta­ble shows, listed so­cial net­work­ing stocks are trad­ing on some pretty ex­trav­a­gant earn­ings mul­ti­ples.

Tech­nol­ogy an­a­lyst Paul Whit­burn, of as­set man­age­ment house RE:CM, has re­cently been cau­tion­ing in­vestors against the frothy hype be­ing drummed up about so­cial net­work­ing com­pa­nies. He hits on a very sim­ple point: while many of the big name so­cial me­dia com­pa­nies

are com­mand­ing “eye­balls” they haven’t been able to con­vert that into rev­enue. Whit­burn de­scribes such val­u­a­tions as “ex­ces­sive”.

Apart from the val­u­a­tions, Whit­burn says there’s an­other fun­da­men­tal is­sue be­ing over­looked when it comes to pre­dict­ing the growth lev­els at­tached to those net­works – the in­abil­ity to grow across mul­ti­ple ge­ogra­phies. “That makes it dif­fi­cult for so­cial net­works to grow glob­ally and achieve crit­i­cal mass in lo­cal re­gions. A very good ex­am­ple of that are so­cial net­works, Ten­cent in China and VKon­takte in Rus­sia, which have both not ex­panded be­yond cer­tain re­gions.”

The ob­vi­ous ques­tion: If the as­set man­age­ment can see “bub­bles” in the sec­tor, then what’s driv­ing the in­cred­i­ble de­mand for those shares? Per­haps the best start­ing point is for

Finweek to take off its “in­vestor” hat and go and ask a South African who has been liv­ing in Sil­i­con Val­ley to ex­plain some of this mad­ness.

“Peo­ple who scream bub­ble are typ­i­cally the ones who didn’t get in on the ground level and want the whole thing to crash down on them so they can feel bet­ter about them­selves,” says tech­nol­ogy in­vestor Vinny Ling­ham. He dis­misses the ar­gu­ments about whether so­cial me­dia com­pa­nies are worth US$30bn or $100bn, say­ing many such com­pa­nies are in­cred­i­bly prof­itable. Rather, he says, the hype about those shares is driven by lim­ited liq­uid­ity.

“Peo­ple want the shares badly – but there’s a lim­ited free float. How­ever, there’s enough sup­port on the down- side that if Face­book couldn’t sup­port a $100bn val­u­a­tion there are more than enough buy­ers at $50bn,” says Ling­ham.

Finweek points out there’s a per­cep­tion smart in­sid­ers are sell­ing to un­sighted out­siders who are plug­ging the shares to clients amid the hype.

But Ling­ham ar­gues that isn’t the case. “Why do you think Face­book is de­lay­ing its IPO? Those on the in­side are say­ing: Yes, sure, don’t buy any stock right now – we want them all.” Ling­ham adds those truly want­ing to un­der­stand how to value tech­nol­ogy com­pa­nies and whether they’re worth their val­u­a­tions need to get their heads around Met­calfe’s Law (see sep­a­rate box) and then try and cal­cu­late whether they’re get­ting value for money in their in­vest­ments.

What so­cial net­work would Ling­ham be buy­ing into if he had a choice?

“First, buy­ing Face­book be­fore its IPO isn’t a good idea. The mar­ket is over­heated on the sec­ondary ex­change val­u­a­tion at $80bn and I’ve some con­cerns about liq­uid­ity – as it’s go­ing to be the big­gest IPO in his­tory. And I’m not sure where they’re go­ing to price, be­cause it’s a blind mar­ket and there are no fi­nan­cials read­ily avail­able.”

His pick would be In­ter­net ra­dio of­fer­ing Pan­dora, which has re­cently gone to mar­ket. Ling­ham says the In­ter­net ra­dio is able to cross mul­ti­ple ge­ogra­phies and rep­re­sents a gen­uine growth mar­ket.

It’s easy enough for a tech­nol­ogy guy to ar­gue for no “bub­ble” but is there a mid­dle ground from fi­nan­cial mar­ket an­a­lysts? For in­vestors bat­tling to get their heads around the growth ver­sus val­u­a­tion sto­ries per­haps it’s eas­i­est to bring it back to a home-grown ex­am­ple in the form of Finweek par­ent Naspers, which holds di­rect and in­di­rect stakes in com­pa­nies such as, Ten­cent and Face­book. Ten­cent and Group make up around 84% of Naspers’s mar­ket cap, so they aren’t a bad proxy for those so-called “so­cial me­dia” plays.

A re­cent re­port by Cit­i­group tech­nol­ogy an­a­lyst Rhys Sum­mer­ton sug­gests that there may be. Com­ment­ing on Naspers, he says one of the chal­lenges the busi­ness

faces is the abil­ity to ap­pease two dif­fer­ent sets of stake­hold­ers: namely, one set of in­vestors will­ing to pay up for In­ter­net ex­po­sure and the group that wants to see cash.

In is­su­ing a “buy” rec­om­men­da­tion on Naspers – with a price tar­get of R500 – Sum­mer­ton praised its man­age­ment for im­proved com­mu­ni­ca­tion about the In­ter­net busi­nesses and the shift in fo­cus to­wards or­ganic growth, as op­posed to growth by ac­qui­si­tion. “We wel­come that ap­proach, as we feel the adage ‘What fools do to­day, wise men did 5 years ago’ ap­plies to emerg­ing mar­ket In­ter­net in­vest­ing and that in­vestors can now look past the val­u­a­tion of po­ten­tial IPOs and in­stead fo­cus on the big hold­ings Naspers al­ready has.”

That con­cept is fur­ther un­packed by Steve Mein­t­jes, head of re­search at Imara SP Reid, who says in­vestors should en­sure they un­der­stand where the busi­ness is in its growth cy­cle. A clue for in­vestors is the amount of money be­ing al­lo­cated to the de­vel­op­ment costs of the busi­ness. “The

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