The Social Media Bubble Starts to Burst

Investors who bought shares of Facebook or Groupon must finally face it: They bought the hype.

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Score one for the Luddites: Social media really does seem to be overblown, at least as a business proposition.

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The Facebook initial public offering earlier this year was supposed to mark the launch point for a new social-media infrastructure that would soon dominate our lives the way Google, Microsoft and Apple do now. Instead, Facebook and its brethren seem to be in retreat, as the market punishes them for underperforming.

In its first earnings announcement since going public, Facebook announced respectable growth in its user base and in year-over-year revenue, while meeting Wall Street's modest expectations for earnings. But its profit margin declined from a year earlier, and it failed to deliver the kind of explosive growth many investors expected just a couple of months ago, The company's rapidly slowing growth makes it highly unlikely to be the next lighter-than-air technology titan.

Facebook's abrupt comedown makes it an easy target, yet several other social-media firms are also reeling. Here's how the stock prices of some prominent tech firms have fared since going public over the last 14 months:

Facebook (IPO date, May 17, 2012). Stock down 26 percent.

Zynga (December 15, 2011). Down 69 percent.

Groupon (November 3, 2011). Down 66 percent.

Pandora (June 14, 2011). Down 43 percent.

You might get the impression from perusing this short and disconcerting list that the IPO market overall has been doing poorly. Facebook's IPO was so disruptive, in fact, that afterward there was a lull of more than a month before another U.S. firm went public.

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But these social-media wipeouts are the laggards, with the rest of the IPO market showing encouraging signs of revival after a near halt caused by the recent recession. The volume and value of IPOs have both been rising sharply, according to consulting firm PwC, which tracks initial offerings. IPO activity in the second quarter of 2012 reflected "ongoing strength and attractiveness of the IPO market," PwC said in a review of second-quarter activity.

Overall, the share price of firms that went public this year has risen an average of 14 percent, according to Scott Sweet, senior managing partner of advisory firm IPOBoutique.com. (And that includes the Facebook debacle.) The overall stock market has risen by just eight percent. So new firms in general are outperforming the market, as fast-growing companies should.

A few examples: Shares of Guidewire, a cloud-computing firm that went public in January, are up 94 percent since then. The stock of Greenway Medical, which specializes in digital medical records, is up 43 percent since its February IPO. Travel site Kayak, which just went public in mid July, is already up 25 percent.

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So why have social-media offerings turned out to be such dogs? One reason, ironically, may have been the success of LinkedIn, the business-networking site that went public in May, 2011. In some ways, that was considered a test case for new social-media companies, and the results of the IPO were intoxicating. LinkedIn stock, set at an offering price of $45, nearly doubled on the first day of trading. The frenzy generated terrific buzz for the firm, but it also suggested the firm's underwriters had badly underpriced the stock, which means early sellers could have cashed in for a lot more.

That may have led the underwriters for other social offerings to overprice the shares, benefiting insiders who sold at prices higher than the market could bear, but making the firms themselves look shaky as their share prices promptly fell.

Another factor may have been the popularity of name-brand firms like Groupon and Zynga, which had millions of users before they went public. "Brand awareness always helps sell the IPO," says Sweet. "But these are firms with business plans that make little sense, in industries where there are very low barriers to entry. That's why they're trading where they are now." In other words, retail investors bought the hype without doing their homework on such firms' long-term prospects. Online-game company Zynga, for example, recently reported earnings far below expectations, with some users moving from computers to mobile devices or simply losing interest in Zynga's offerings.The Facebook IPO turned out to be a humongous embarrassment, with small investors clamoring for shares that lost value almost immediately. The fiasco has saddled a true breakthrough company with nagging investor skepticism.

Yet the whole ordeal has also highlighted a unique aspect of social media that investors momentarily lost sight of: Though it continues to grow as a powerful technological force, social media remains difficult to monetize consistently. By nature it is ephemeral, vulnerable to other types of disruptive technology, and resistant to the kinds of corporate controls that Apple and Google are capable of instituting.

That's why talk of a Twitter IPO has receded to a whisper. The ubiquitous messaging site continues to grow exponentially, but enthusiasm for a public offering has waned. There are better ways to invest your money than to risk a repeat of the Facebook IPO.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.