Is it time for social media to go conservative?

12th September 2012

If you're not valued at a billion dollars these days, it seems you're not really trying, as it can appear all too easy.

Take the recent example of Instagram and, of course, Facebook, with stock that kept slumping in price from $38, the offer price on its IPO, into the $20s and below.

Yet the basic principle of investing is to put your money towards the profits of the future. But without any obvious revenue stream for many of these social media companies, this makes this tricky.

You are certainly taking a risk by ploughing capital into such a company as Facebook.

Of course, the investment mantra goes that with risk can often come great reward – but fundamentally, surely a strong business plan and path forward is needed? Otherwise, you might as well go to the casino and place your money on black.

According to the Atlantic, Paul Graham, cofounder of tech incubator, Y Combinator, sent an email to his portfolio companies predicting a shift in the way venture capitalists evaluated start-up potential.

Before the public offering, companies that build a large audience were not under much pressure to build a revenue model to match. But "the bad performance of the Facebook IPO will hurt the funding market for earlier stage startups," he wrote, "possibly a lot, if it becomes a vicious circle."

Meanwhile, Business Insider reported that investors in Tumblr, "a giant social blogging platform", are demanding a business model to match the awesome growth in users.

Nick Kirrage from Schroders has misgivings about IPO's – particularly those of social media companies, because of the hype and the speed of new competitors on the scene.

He says in a Mindful Money blog post: "In the past, in articles such as Fear of the new, we have highlighted our misgivings about initial public offerings (IPOs) in general, and particularly about those of new tech businesses such as social networking sites and search engines…

"When it comes to new tech companies, it's easy to think about the handful of successes, such as Amazon and Google, to the exclusion of the many dozens of businesses that failed. In investment, how can it be right to focus only on the few that have succeeded beyond anyone's wildest expectations? Everybody wants to find that diamond in the rough but unfortunately it's unlikely.

"Of course Facebook has shown impressive growth in recent years but does that mean it can continue at the same rate? This is a company that, in the space of just eight years, has gone from nothing to capturing over 900 million users but does that mean it is a wonderful business or that, if a competitor gets its product right, it can take an enormous amount of market share? In a world of Tech 2.0, what is to stop Facebook 2.0?"

It's difficult to pinpoint a clear revenue stream for Twitter, and it didn't exist a decade ago – like many on the scene – so it'll be interesting to see where the land lies a decade on.

However, there are some that might prove more promising. Spotify, unlike the billion dollar Instagram, at least already has a hefty revenue stream. But still, can it justify its $4 billion valuation? And it has competitors with the likes of Omnifone – the British firm that powers music streaming services from Sony and Blackberry – posting its first annual profit.

So it seems that social media shares are quite some bet to take. Are there enough credible investments out there to make?

"The first few years of the social media revolution have been a golden age of tech utilitarianism, where maximizing users' delight was considered, quite literally, the only currency that mattered," says the Atlantic.

But the landscape is poised to change from attention to profit.  Could this lead to social destruction, or simply a more conserative approach?

 

More on Mindful Money:

Is Mark Cuban right to blame investors for Facebook IPO?

Direct Line IPO: What investors need to know

What investors can learn from Dr Dre and Justin Bieber

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