Sky high social network valuations: for what exactly?

Few technologies have generated more buzz in the past few years than social networks. Take Facebook for instance: strong user growth, the launch of 'F8' (an open developer platform), an acquisition (Parakey) and an investment from Microsoft, after repeated rebuffing of other generous suitors, has generated a frenzy of attention from all sectors of the media. I haven't been able to stop myself recoiling from some of this 'jump on the bandwagon' enthusiasm after hearing several incredible rumours surrounding 'potential social network buy outs'. While Microsoft has put at least one speculation to rest for now, taking what looks like a defensive 1.6 per cent stake in Facebook and valuing the company at around $15 billion, Facebook has suffered a decline in unique users in the UK for the first time since July 2006. This means a drop of 5 per cent, to 8.5 million users in January. Still, the social networking site remains the most popular in the UK (according to Nielsen). In fact, a columnist for a leading financial newspaper advised founder Marc Zuckerburg to ignore all advances and hold out for the 'inevitable' post-IPO $100 billion market capital. Now, there is no doubt that 2007 has been a stellar year for most social networks, and definitely for Facebook, but $100 billion? Now, a look at any business's revenue provides a small amount of perspective, and in the social network sphere, highlights the sheer level of excessive over-valuing here. Facebook's revenue for 2007 was somewhere around the $100 million range, a figure made up almost exclusively of display advertising revenue. With almost 50 million registered users, revenue per user lies in the region of $2 per member. Convention on Wall Street would suggest a typical price to earnings ratio for a high growth company of this nature would be up to 20. And even this very bullish estimate would only peg Facebook's value at $2 billion. If the company manages to double revenue per user and somehow sustains a 50 per cent year on year growth rate, it will begin to justify the valuation around 2018. But by then it will need to have 3.5 billion users, roughly half of the projected global population. Social network growth has been huge news throughout 2006 and 2007, but now, there are a host of additional challenges that also seem to be swept under the mat at every turn: 1. Social networks seem intent on achieving revenue growth through advertising, but they are already notorious within the online ad sector for not delivering the best performing campaigns around. As the industry shifts away from CPM pricing toward a greater awareness of measurability, this will hurt any social network's ability to monetise. 2. You can be sure that a host of social networks will release their own APIs within the next six months. MySpace's greater numbers, for a start, will then make it potentially attractive for developers and therefore make it hard for smaller, niche networks to compete. 3. And what will any network do when third party apps built on their developer platform or API start to outperform the site itself? This will come in time. 4. While the user experience of MySpace is often depicted as messy and full of spam, it has only become so with scale. Smaller networks will also face the same challenges with growth. 5. Privacy is a hot topic at the moment with the Tier One providers (Google, Yahoo, MSN, Ask and others) engaged in an arms race to allay privacy concerns that were initially raised by European regulators. When this filters down to Tier Two, things will get interesting. Where a search engine has behavioral search data on its users that can be analysed to hypothesise user habits, social networks contain personal revelations for members, as well as a network of familiars that can be used to all manner of unsavoury purposes. Unfortunately I'm not about to share great wisdom, and provide an answer to whether social networks will live up to expectations or not. I don't have an answer, but I do believe that there are so many pitfalls and levels of expectations are so high that they seem almost impossible to reach. While many things are unclear about social networks, one thing is abundantly clear. People like them, and find value in them. And where there is value, there is the potential to make money. We just need to work out how. Grant Keller is director EMEA, Acceleration.
 

Comments

Norman Rosenberg
Norman Rosenberg February 26, 2008 at 5:38 AM

Inevitably the valuation for Facebook was completely overstated. In time Microsoft's acquisition of a minority share in facebook may come to represents the apex of of a social network wave. There is definetly the scent of consolidation, for example ONESite's acquisition of Social Platform, Jaiku's acquisition by Google etc, and commodisation of teh technology, Ning etc, in the air. I think a lot of networks who will probably not achieve their second round revenue targets particularly in a period of flat or declining advertising.

Value to the user is driven by nicheness yet money is to be made from leveraging economies of scale. Difficult balance to achieve and I suspect to many strategies are still running on acquisition mode. However I agree with the author of this piece value , and therefore money, is being created. Just wish I had a $100b valuation to worry about.

Norman Rosenberg
www.raineyrosenberg.com


The Internet still has a get rich quick/gold rush mentality. Sure Larry Page, Jerry Yang have gone from zero to billionaires overnight but for everyone of them there are thousands of businesses that are just not sustainable