There is a raging but inconclusive debate occurring in the US as to whether soaring valuations for so-called “social” companies are reflective of a boom or a bubble.

While some of the valuations are staggering — Facebook is being valued at more than $US75 billion in private secondary market trading and, after a $US950 million equity raising by Groupon late last year placed a $US5 billion value on the shopping site it is now being talked about as a $US15 billion-plus float — valuations by themselves don’t distinguish between boom and bubbles.

Google, Amazon and eBay were, after all, created during the dotcom boom of the 1990s that morphed into a bubble that imploded in 2000. They have validated what once appeared to be impossibly optimistic valuation metrics. Apple’s iTunes, which has transformed the distribution of music and laid the foundations for the even more transformative app store, was launched in 2001 after the dotcom bubble and associated boom in technology stocks had burst.

There are similarities between today’s boom in social companies and the 2000 bust. Now, as it was then, it is the size of the audiences — the number of eyeballs — rather than the degree to which they might be monetised that is driving valuations.

A key difference, however, is that companies such as Facebook and Groupon actually have revenues and earnings so the question isn’t whether they can monetise their users but rather the extent to which they can grow them.

Twitter, still searching for a sustainable revenue model, is in a somewhat different category but given the size and engagement levels of the user base it has built in only five years — it is said to have about 200 million users — relatively modest revenues per user would translate into a lot of commercial value.

The fact that the flag-bearers for the latest dotcom boom aren’t rushing to public markets and are proving their ability to generate revenues and earnings is a major differentiator between the latest hopefuls and their 1990s predecessors.

Another major difference is in the size of the potential audience/market. In the late 1990s the number of people online was about 55 million. Today it is more than two billion. Facebook alone has more than 600 million users.

Then internet access was dial-up. Today it is fixed and increasingly mobile, at rapidly increasing speeds as high-speed fibre networks such as the National Broadband Network are rolled out and mobile technology moves into its fourth generation.

With a far, far larger potential audiences, the emergence of open-source products and the emerging shift to cloud computing it is now far easier and cheaper to build and commercialise online businesses. The inherent leverage in the online model underwrites relatively high valuation multiples once they get past break-even, or appear likely to.

The 1990s boom/bubble was indiscriminate. Anything with a dotcom in its name boomed, whether it had a business model or not. In this market, tiny miners only had to announce they were looking at investing in internet-related activities to see their market capitalisations double or treble — before they actually bought or developed anything online.

In this boom we’ve yet to see the metaphorical bellhops in the market, largely because most of the stocks being hyped have yet to list.

Their valuations are being driven by venture capital and professional technology investors, although there are concerns among US regulators that less-than-transparent secondary markets have developed for some of the bigger companies’ securities. Against that, the amount of venture capital raising in the US in this latest round of dotcom excitement is a fraction of what was invested in the 1990s.

One disconcerting aspect of the new boom in social media is the MySpace experience, where the emergence of Facebook overwhelmed and ultimately destroyed an established player. Groupon’s success has spawned a multitude of copycats.

There’s an element of fadishness to the “next new thing” in the social media space that adds to its risk, although the Google experience, and the extent to which Facebook has embedded itself in its users’ daily lives, also highlights the extent to which a dominant network’s success can be self-reinforcing and fuelling.

Is it a bubble? Probably not at this stage, although individual companies might prove to have been over-hyped and over-valued once the benefit of hindsight is available. Could it develop into a bubble? Most prolonged booms do, as the temptation to get rich quick turns investors into speculators.

This first appeared on Business Spectator.

Peter Fray

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