The social bubble is bursting

28 Mar 2011

In his look back on the week, editor John Kennedy argues that growing scepticism over the valuations given to social media companies in Silicon Valley is overdue and may prevent the rest of the tech industry from being scarred.

The strong reaction to a new social networking service called Color raising a whopping US$41m in venture capital may be the icing on the cake.

For some time now, concerns have been raised that the massive valuations put on social media firms has been getting out of hand.

But in recent days, thundering disproval has reached something of a crescendo; and this disproval comes from people who really care about the technology industry overall and don’t want to witness another bubble bursting like that of March 2000.

It is much different this time. In a post-recessionary world (yes, the recession is over for a lot of countries, actually) the technology industry is one of the few bright spots of growth, creating thousands of jobs and many avenues for various nations’ potential prosperity.

The past two years have seen the growth and growth of an industry spurred on by innovation and demand for devices like the iPad, the iPhone, Android smartphones, Kindle e-book readers, 3D and HD televisions, and of course, the Kinect. We have seen demand for apps for media tablet computers, record demand for software platforms like Windows 7 and mobile operating systems taking centre stage. But this is just scratching the surface of an industry that is hedging bets on big trends like cloud computing, desktop virtualisation and not just social media?

Is Silicon Valley running out of ideas?

Yet if you read any of the press to emerge from the epicentre that is Silicon Valley, it’s all about social media. This is scary, because it suggests Silicon Valley – a place like no other where such a fusion of talent, innovation and money exists – is running out of ideas. The biggest and most exciting thing to happen in the Valley for months seems to be questions-and-answers service Quora. The general feeling post-South By South West (SXSW) in Austin, Texas, the new media event where Twitter was ‘discovered’, was that aside from Angry Birds, not much is happening.

Just think of the valuations attached to Facebook (US$50m), Zynga (US$10bn), Groupon (US$4.8bn), LinkedIn (US$2bn) and, of course, Twitter (US$4.5bn). It’s no wonder there is such attraction to social media.

Let’s be clear, I adore social media and I think it is changing the world, technology and media and fundamentally our lives on so many levels and the story is really only beginning. But let me also be clear, it isn’t the only game in town. Investors need to remember this.

Exciting things are happening in microelectronics, in biotechnology, on pharmaceuticals, in medical devices, in cloud computing, in mobile and in digital entertainment. Social media could well be the glue that will unite many of the breakthroughs to come and will certainly flow through the digital home and digital lifestyle. But if investor sentiment believes that social is the only game in town and the only thing worth investing in right now then this would be tragic.

Comparing the 1999 tech bubble with the 2011 tech bubble

The New York Times yesterday published an interesting story on how banks, wealthy clients and institutions are clamouring for a bit of the action, evoking memories of the gold rush of 1999/2000. It published an interesting infographic that showed 24 companies in 1999 – including WebVan, Infonet, eToys and Agilent Technologies – whose valuation amounted to US$71bn.

Alongside this was a similar infographic that included five companies – Twitter, Facebook, LinkedIn, Zynga and Groupon – whose valuation in 2011 also amounts to US$71bn.

The one key difference is the latter group are not yet publicly listed, but that does not mean that feverish trading is taking place. On the contrary, investors can’t get enough.

CNET and Bloomberg reported over the weekend on how Warren Buffett is warning investors to be careful about which social networks they friend with their investment dollars. The chief executive of the Berkshire Hathaway investment empire warned investors Friday at a conference in New Delhi to be wary of social networks – such as Facebook and Twitter – a sector that has recently generated great interest and anticipation on Wall Street.

“Most of them will be overpriced,” Buffett said. “It’s extremely difficult to value social-networking-site companies.” Some will be huge winners, which will make up for the rest, he said, without specifying which companies he expects to be winners and which will be losers.

Buffett isn’t alone in his dire warnings of another bubble in the offing. IAC founder and former entertainment mogul Barry Diller recently called the multibillion-dollar valuations of social-networking companies with high user engagement but unproven long-term revenue “mathematically insane.”

I think the fundamentals are there to say the technology industry overall is in rude health. It is firing on all cylinders. And, of course, the difference between the five social networking giants valued at US$71bn and their counterparts in 1999 is that the social networking players of today are actually cashflow positive.

However, it does point to a worrying trend amongst investors to put all their eggs in one basket. It points to a lack of imagination on the part of venture capitalists and institutional investors. It would be a shame if this was to have a detrimental effect on a global industry that is powering ahead.

Social media is great, but it’s not the only game in town.

John Kennedy is a journalist who served as editor of Silicon Republic for 17 years