How to invest in the social-networking IPO boom!

How to invest in the social-networking IPO boom 

By Rex Crum 
Jun 3, 2011 00:01:08 (ET)

SAN FRANCISCO (MarketWatch) -- Call it a wave or a bubble, or something else entirely, there is no question that initial public offerings of social-networking companies have taken hold of the minds -- and wallets -- of investors looking to get in on the next big thing in tech stocks.


As if any further evidence of that was needed, it was found in the May 19 IPO of online professional-networking company LinkedIn Corp. (LNKD, Trade ), which went public at $45 a share, climbed as high as $122.70, and ended that day at $94.25 -- a gain of 109%. Following that initial burst LinkedIn's shares have settled a bit, trading at around $60.00


But the response to LinkedIn has set the stage for other social-media IPOs, including the anticipated stock offerings of the biggest of the social-media giants, Facebook, which is believed to be readying itself to go public next year.


On Thursday alone, online daily deal site Groupon filed to go public with an IPO aimed at raising $750 million, while streaming radio company Pandora set a price range of $7 to $9 a share for its upcoming IPO. And investors are also eager for IPOs that are expected down the road from the likes of Twitter and social-gaming company Zynga.


"For a while, an IPO wasn't seen as a viable exit option. If the market is coming back to life, that's probably a good thing," said Bill Maris, managing partner of Google Ventures, the venture capital unit of Google Inc. (GOOG, Trade ).


"It's a commitment when you make an investment, and we want the companies we invest in to grow and be successful," Maris said. Last week, for example, Google Ventures made an investment in Kabam, a social-gaming company that claims to have 60 million users. Google Ventures didn't disclose the dollar amount of its stake.


While social-media companies are in the tech spotlight, so are questions about the enthusiasm for investing in the social-media sector. Looking at LinkedIn's rocket launch, it's worth remembering how shares of Internet browser company Netscape more than doubled on their first day of trading in August 1995. That IPO helped spark a dot-com mania that by early 2000 had investors swarming over dubious newcomers including online grocer Webvan and pet-products retailer Pets.com.


Is another Internet bubble on the way, or does the business of social-media companies differ significantly from the Web darlings that captivated the market in the first dot-com boom -- and fell hardest in the subsequent bust?


"Is this a bubble?" asked David Weir, chief executive of SharesPost, an online platform for investors to gain access to stock in privately held companies including Twitter and Facebook.


Weir doesn't think so, at least when it comes to the pace of IPOs and the quality of the companies in the pipeline.
"If you look at the number of IPOs between 1990 and 2000, the average was over 500 a year, and during the bubble that was in the same ballpark," he said. "Since then, there have been 120 to 130 on average."
Weir said part of the decline in IPOs, especially among tech companies, is because companies are staying private longer and building up evidence of actually being able to do real business and generate revenue, if not profits off the bat, than was true in the past.


All of which makes these social-media outfits particularly attractive when they do go public. "There are fewer dynamic companies to invest in and that is driving the appetites of investors," Weir said.


Sumeet Jain, a principal with venture capital firm CMEA Capital, added that the value given to many social-media companies stems from the fact that many of these websites have created a huge shift in how people use the Internet.
"
The companies of today are really disrupting how people go about their daily lives and do their work," Jain said. "Almost every professional I know uses LinkedIn, and you can see all kinds of relationships being affected by Facebook."


Jain said CMEA Capital has made investments in several social-media companies, including Blekko, a company doing Internet search, social job-recruiting site Jobvite and Pixazza, a company working it the social-media industry for publishers.


As happened in the dot-com bubble, the anticipated valuations of some of the top social-networking firms has grabbed the market's attention. The poster-child for high valuation before going public is Facebook, with analysts estimating the company could already be worth between $50 billion and $70 billion. By contrast, Yahoo Inc. (YHOO, Trade ), which it can be argued was the king of the Internet a decade ago, currently has a market capitalization of around $22 billion.


Gene Munster, who covers much of the tech industry for Piper Jaffray, said that while valuations may appear high for social networking plays, these companies are under much more intense scrutiny than the Pets.coms of the first dot-com era. Back then, just about any company could get venture funding and then go public with little more than an idea and a lot of talk about the potential for big sales in the future.


Munster said that script has changed. Facebook, he pointed out, is believed to have brought in around $2 billion in revenue in 2010, and estimates peg the company's sales at between $3.5 billion and $4 billion this year.


"The guards are up, and the biggest difference is that these companies actually need to show results," Munster said. "In 1999 and 2000, business models didn't need to have any revenue until a year or two down the road. The willingness to pay [for] high valuations is unchanged, but there is a lower tolerance for risk and much more desire for results. Immediately."


Analysts who follow social media say that companies in the sector face challenges to gain and keep the faith of investors who might still be skeptical after getting burned during the initial Internet gold rush.


"Social networking at its core is social engineering," said Rob Enderle, president of the Enderle Group. "It's an industry that has so much to do with how people interact, but for many companies, their expertise is in technology. For their long-term health, you need to be experts on people."


Josh Bernhoff, of Forrester Research, added that for a social-media company to truly succeed, it needs to show three things: how quickly it is growing numbers of members, how much time its members spend on the site and how the company is able to turn all those users and time spent into actual dollars.


Would-be investors take note. "People need to be more realistic about the prospects for social-media," Bernhoff said. "Unlike the last time around, there has to be some real value. There is no appetite now for investing in vapor and hope. Those times are past."