Pandora Media Inc. raised more than $235 million in its IPO, which put the company's value at $2.78 billion. And recent paperwork from Facebook Inc. values the social media giant at $100 billion. Facebook is positioning to hold its own public offering in early 2012.
With social media gaining ever more attention, almost all of the high-profile online services see an opportunity to cash in on their popularity by offering shares to the public. However, unlike Apple Inc. or Research In Motion Ltd., which make products to sell to consumers, social media websites don't really sell anything.
The sites provide places for people to gather, share deals, listen to music or share job leads -activities that aren't exactly conducive to supporting a growing, cashhungry business. And many, such as Groupon, which provides online coupons for special offers at local shops, and Pandora, which allows people to customize an Internet radio station based on their musical tastes, are easy to imitate. Knockoffs such as Living Deal and Slacker Radio have already popped up.
"This is the big problem. You start looking at Groupon and there is no reason to believe that Google, which has a long history of very good software development, can't replicate what Groupon has done very easily. When you get down to it, all they are doing is electronically sending you coupons. It's the same with a lot of these things," says Laurence Booth, a finance professor with the Rotman School of Business at the University of Toronto.
"Pets.com (an online pet food vendor) went from a market value of $10 billion to bankruptcy in a span of 18 months. I would look at all of these (IPOs) as being very risky."
Groupon's growth has been stunning. As of the end of March, 83.1 million people in 43 countries had signed up for its daily deal newsletter. Its revenues jumped to $714 million in 2010 from $94 million in 2008. In the first three months of 2011, it reported sales of $644.7 million.
That still wasn't enough for the Chicago-based company to turn a profit.
According to the regulatory filings that are mandatory in preparation for an IPO, Groupon's sales growth between January and March couldn't offset a $102.7-million loss. And the company doesn't expect to see profits anytime soon.
It's important to note that mandatory regulatory filings must include all possible negative scenarios that could affect the company after its IPO, so potential investors know the risks.
"We have incurred net losses since inception and we expect our operating expenses to increase significantly in the foreseeable future," reads the company's filing. "We may not maintain the revenue growth that we have experienced since inception . we do not know whether this market will continue to develop or whether it can be maintained."
Groupon isn't alone.
LinkedIn, a website that allows professionals to network and share job opportunities, issued a similar warning before kicking off its IPO last month. After losing money since 2008, LinkedIn turned its first solid profit -$10 million in net income -between January and September 2010. LinkedIn, which has more than 90 million members in 200 countries, reported sales of $161.4 million for the first nine months of 2010, but warned investors that tough times lie ahead.
"We expect that, in the future, our revenue growth rate will decline, and we may not be able to generate sufficient revenue to sustain our profitability," reads the company's regulatory filing. "We also expect our costs to increase in future periods, which could negatively affect our future operating results. In particular, in 2011, our philosophy is to continue to invest for future growth, and as a result we do not expect to be profitable."
On its first day on the New York Stock Exchange, LinkedIn's shares more than doubled to close at $94.25.
Pandora is another example. Despite having 80 million registered users listening to its radio service in the United States and more than $90 million in revenues, Pandora lost $328,000 in the last nine months of 2010 (in the company's current fiscal 2011 year). That was a big improvement over the $15.5-million net loss it reported for its full fiscal 2010 year (which ended Jan. 31, 2010) or the $27.4-million net loss it reported in 2009.
Yet on Pandora's opening day of trading this week, shares shot to $24 before falling to $17.42, for an 8.9 per cent gain on their opening price. In just one day, Pandora vaulted to become about 10 times more valuable than Internet "e-tailer" Amazon.com Inc. and 20 times more valuable than broadcaster CBS Corp.
Finding observers in favour of the ballooning IPO prices is a difficult task. The University of Toronto's Booth said consumer interest and opportunistic day traders are fuelling the rapid price increases seen over the past few weeks.
"What's happening now is that people are looking for the first day bounce," he said. "They are looking for the stock price to jump up, 20 per cent or 30 per cent because there is a lot of interest in all of these."
The fast-rising valuations in social media firms have drawn immediate comparisons with the dot-com run-up in the late 1990s when Internet grocer Webvan was valued at $1.2 billion and Internet toy retailer EToys.com hit an $8-billion valuation. One of the original social networking services, theGlobe.com, became the world's fastest rising IPO, with shares that started at $9 rocketing to $97 before closing at $63.50, for a 606 per cent increase in a single day. At its peak, theGlobe.com was valued at $840 million.
"We hope that we learn from our mistakes and that is not always the case," says Steve Foerster, a professor of finance at the Richard Ivey School of Business at the University of Western Ontario. "It is to some extent a leap of faith that there is going to be a business model (for these new companies) that will provide positive cash flows consistently."
According to Pliniussen of Queen's University, potential investors eagerly watching the social media IPO frenzy of 2011, much like those who invested in the dot-com bubble of the late 1990s, are not concerning themselves with financial performances.
They think of the IPO as a lottery ticket, and the only way to grab a piece of a company's potential profits, says Pliniussen. It's the hope that these companies will turn future profits that is driving the buzz.
"We don't know what the upside is. With the amount of users they are getting, if they could monetize that the cash flows would be enormous." Pliniussen says.
"We are not rational investors. People buy based on emotion. There is a sense of excitement. When Google came out at $100 (per share), everybody was extremely skeptical. The rest is history. That same faith in future speculation is happening again."
Above all others, Facebook is the social media company that is being touted as the next Google. A global Goliath, Facebook has more than 680 million active users.
While Facebook is rumoured to be preparing for an IPO next year, the company has not yet filed any of the required paperwork. However, with a company this big and high-profile, information about its finances has leaked.
According to MSNBC, Facebook earned $600 million in 2010, marking its second straight year of profitability. In 2009, its profits were reportedly in the tens of millions of dollars. Prior to that its been reported that the company has been unprofitable since its launch in 2004.
By comparison, Google reported three years of solid profits prior to listing its shares on the public exchange. Google earned $11 million in 2001, $187 million in 2002 and $342.5 million in 2003. In the six months leading to its IPO in August 2004, it earned $326.3 million. Google shares opened at $85 and closed that day at $100.34, valuing the company at $27.2 billion. The company's shares were trading above $489 on Friday, valuing Google at $157.9 billion. The company reported more than $8.58 billion in revenues and a $1.8 billion net profit during the first three months of this year.
But while Google, with its Internet search engine paving the way, has seen demand for its products increase in the years since its public debut, most other social media firms are already struggling to maintain consumer support.
According to the website Inside Facebook, the social media giant lost six million users in the U.S. and 1.52 million in Canada between May and June. The fall left Facebook with 149.4 million users in the U.S. and 16.6 million in Canada. Facebook also saw noteworthy declines in traffic from Britain, Norway and Russia.
With almost 50 per cent of the population of Canada and the U.S. already active on Facebook, the site could be reaching its saturation point in the North American market. To continue its expansion, it must look at emerging markets such as China, India and South America. There, however, it will face stiff competition from incumbents such as Orkut, Renren and Hi5. Facebook is entering those regions as the newcomer.
Groupon is experiencing similar growing pains. A recent study by Rice University in Houston, Texas, found that 32 per cent of participating merchants said they lost money through their Groupon offerings. Another 66 per cent said they made money, but of all the merchants surveyed, more than 40 per cent responded that they would not be running another discount through the company.
The shaky financial footing and limited growth potential of many of the social media companies should have investors thinking about the extent of the risks involved, says Laurence Booth of the Rotman School.
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