What Social Media companies valuations in the stock market might be telling us

Social Media Valuations and the Tech Bubble
Click to enlarge

After LinkedIn shares tripled their value on the company’s first day in the stock market the question about the Tech Bubble 2.0 has come back into discussion. Reading about it, I found in Mashable this infographic by G+ that shows relevant economic information of big companies in social media business. My question after looking at this data is if we are living a new Tech Bubble similar to the .com bubble in the early 2000’s, which lead to disasterous consequences on the technological industry. It’s difficult to believe investors would trip twice on the same rock, but I think we might be heading in that direction.

Yes, the potential of social media in terms of users, impact and business relationships is amazing, but all these companies have a valuation 10 to 50 times bigger than their annual revenue. In the cases of Delicious or Color, this difference is actually infinite, since neither of these services creates revenue (meaning that investors are giving money for literally nothing!). These valuations, which should be seen as money already invested by other companies or individuals, shows the incredible potential and the large number of people who believe in these businesses.

But it seems to me that they are forgetting the difference between the potential of the business and the reality. These investments are just a bet, the same as putting your money on Red Bull’s team to win the Formula-1 this year: it looks like it’s going to happen and make you rich, but something might go wrong making you lose it all. In the same way Facebook took over MySpace, at any moment a new and more popular social media could pop up, or any other event could happen forcing the company into bankruptcy (from a big investor taking his money back to a court decision forcing them pay a large sum of money for privacy violations).

For example, Facebook costs $75 billion just because a lot of people believe so. There aren’t any stronger reasons for that impressive cipher, other than “potential” and “faith”. If those believers loose faith, the company’s valuation goes immediately down, and it’s a lot of money relying simply on faith.

I believe in social media. I really think it has forever changed the way we communicate, and the relationship between brands and customers. From organizations to individuals, everyone can enjoy and take advantage of these new services, which are going to continue growing. But I work with social media and, even though I see how Twitter and Facebook help our magazine grow in number of readers, I can’t be sure that next year our followers won’t move to a new network which doesn’t even exist yet. That’s why we keep an eye out to discover new opportunities, and why I think these valuations are too high and are reaching the level of a risky bubble.