The increasing pervasiveness of social media is so evident that any discussion, column or news story about it has become clichéd.
Yes, social media is now ubiquitous and has transformed society.
Yes, it is changing the way entities as diverse as members of Congress and rock bands disseminate information and communicate with the outside world.
And, yes, it is enabling millions around the globe to form digital communities with others who in some cases are thousands of miles away.
None of this is news.
But amid Twitter’s recent IPO filing and with Facebook, Yelp and LinkedIn already having gone public, a new discussion has emerged concerning social media, and this time it’s one definitely worth having: Despite the sudden growth (all besides LinkedIn were established less than ten years ago) and the breakneck pace at which such platforms have signed up new users, are these companies worthy of investment or will they flame out like some of the once-hot tech firms, like for example Zynga or Groupon?
Since social media is for the most part free to use and relies primarily on ad dollars for revenue, many investors wonder whether these companies have viable business models to successfully turn the communities they have cultivated into engines that consistently produce returns for their shareholders, a la Google.
Investors need to ask themselves three questions before investing in any social media company:
•Does it have a sustainable loyal audience that will last over time?
•Is it capable of monetizing that audience into ad revenues without
alienating its core audience?
•Has it demonstrated to advertisers that it can provide a reasonable
rate of return on invested capital to drive sales and attract new
With this in mind, the following is a brief look at the pros and cons of the ‘big four’ social media companies:
1. Facebook– Facebook has invested billions to create critical mass, and now that it has essentially penetrated every corner of the globe, it is time to cash in. With its disastrous IPO of last year firmly in the rear view mirror, Facebook’s ad revenues have exploded, especially on the mobile side of its business, where it generated more than 40 percent of its total ad dollars during the second quarter, up from approximately 25 percent the previous year. The stock price has responded accordingly, hitting the $50 mark for the first time in recent weeks. Yet for all its success, Facebook has yet to demonstrate that it has an effective return on investment on their advertising platform for businesses, and it remains to be seen whether the flood of new ads will alienate users who previously embraced its seamless, clean and largely ad-free platform. The one advantage they do have, for now, is they have the most users in the world.
2. LinkedIn – LinkedIn is largely a one-trick pony. But gaining mastery over the professional networking and job search space like no other platform, social media or otherwise, is a pretty good trick. While LinkedIn has attempted to employ a few of the community building functions that Facebook pioneered, its users still consider it in the professional networking niche. That doesn’t worry investors, who take solace in the fact that unlike other social media sites, LinkedIn has a unique business model, deriving revenue from multiple streams, including mobile and web ad sales, premium user subscriptions and selling its database of millions of resumes to corporate recruiters – which has become increasingly lucrative over the years. LinkedIn has really mastered the market for job searching but other than professional networking, it really does nothing else.
3. Twitter – Twitter has generated considerable buzz recently after it filed an IPO notice with the SEC, punctuating its meteoric rise, even by tech standards. In a little more than seven years, Twitter went from fledgling start-up to one of the most influential communication platforms in the world, today boasting more than a quarter of billion users who send approximately 58 million ‘tweets’ a day. Much like Facebook, the question right now for Twitter isn’t whether it can attract advertisers (It can). The real question is whether this is a monetizable format over the long term. Most users use Twitter to send or read quick, short bursts of information, and it’s not clear that they will be receptive to appeals from advertisers. It is also not clear whether advertisers will see a return from paid advertising on Twitter. They do have the mobile space covered but that does not lend to display ads and too many tweet ads will definitely change the seamless experience that it currently offers.
4. Yelp – Yelp perhaps best satisfies the core constituencies of all social media companies: users, advertisers and investors. For users (consumers), it has basically become the real-time online and mobile version of the Better Business Bureau, providing valuable insight into a broad spectrum of businesses, from restaurants to clothing retailers to plumbers and even health care professionals. For advertisers, it is hard to beat, because it allows businesses to reach customers who are actively looking to buy their goods and services. Yelp generates good returns for its advertisers and provides reliable reviews for businesses, whether the business likes it or not. There is no other review site like it and it has achieved critical mass.
At this point, investing in social media companies is somewhat uncharted territory. If the dot-com bubble of the late 90?s is any indication, it will not be for the faint of heart. Many of the social media companies have reached stratospheric valuations. This creates the dilemma of whether all the good is priced in or over time, these companies will end up looking like cheap stocks in hindsight, similar to Google and Amazon a decade ago. Clearly the risks will outweigh the potential outsized reward for many with shorter time horizons or different objectives.
It will be important for investors to perform their own due diligence before piling headlong into any of the above equities (including Twitter, which is expected to go public soon) and remain engaged once they are invested because conditions in the internet space can become unfavorable very rapidly.
Ross Gerber is CEO and president of Santa Monica, Calif-based Gerber Kawasaki (www.gerberkawasaki.com), an independent investment advisory and wealth management firm with approximately $200 million in assets under advisement. Gerber Kawasaki clients and employees may own positions in various companies mentioned in the article. Readers should not construe this article as a research report and should not buy anything without doing their own research.