IT’S A BUBBLE!
WE UNPACK THE SOCIAL MEDIA HYPE FOR SA INVESTORS
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 Mail.ru, Tencent and Facebook. Tencent and Mail.ru 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