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Social media boom and bust is no surprise

Five pounds FacebookTwelve years ago the dotcom industry suffered the effects of rapid boom and bust as mega company after mega company collapsed. However, the internet continued to grow, to employ ever more people and we have continued to see innovation and new companies.

Now, thanks to the rapid rise of social media over the past couple of years, we are seeing another boom and bust story playing out before our eyes as huge corporations suffer the highs and lows of market forces. Facebook floated with the biggest valuation of any internet company ever amid exhuberance about its unending and rapid rise, but in just a few weeks its share price has dropped by more than half, from $38 a share to less than $20 a share.

Groupon was offered a reported $6bn by Google in 2010 – an offer it rejected in favour of making its own public offering on the stock markets. Groupon floated at $20 and initially saw a rise, before it lost 75% of its value to fall to a company valuation that was half of what Google had offered to pay for it in 2010. Analysts expect it to fall further.

What we are seeing is the equivalent of the banking crisis. Money men gambling on stock in order to make money and get out. The founders of these companies become paper millionaires (or even billionaires) when they sell some of their company on the markets, but as soon as you do take your company public you are creating two dangerous scenarios.

First, your brokers and advisors are trying to get the best price for you that they can, so the price needs to be as high as possible. With social media, the prices have been pushed artificially high due to demand. Just as in 2000, everyone is so keen to not miss out on the boom that demand outstrips realistic value, and the price is set to match the demand rather than true fundamentals.

The second problem is that public companies have to report everything that matters to investors, and that means an army of analysts take a close look at their trading conditions, and some of those analysts work for investors who like to short stocks. Consequently, mega companies like Groupon, Facebook and LinkedIn, being public, can be seen to be overvalued if their earnings don’t look strong.

Facebook is a great business and its founders deserve to get their millions from their efforts, but you don’t need to be an analyst to know it was overvalued at flotation. In a goldrush, everything is overpriced. Even LinkedIn, which is currently trading well due to good fundamentals and impressive revenue figures, is said to be too high to recommend as a buy right now.

I’ve been expecting Facebook to announce one day that it will buy Bing. Now I’m starting to think it’s possible that Bing could buy Facebook. Either way, a marriage of the two would be good for both.

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