Are social networking sites the next investment bubble?

Social networking is the fastest-growing internet activity. Internet traffic today, and the data generated by Facebook, is estimated to surpass that of all the world’s e-mail. Facebook alone has half a billion users, a little less than 10% of all the world’s population.

This is quite impressive, but even more impressive is the figure $50 billion, Goldman Sachs’ market capitalization estimation of Facebook, which even more recently has been cited as $82,9 billion. This is equal to twice the annual GDP of the whole of Bulgaria. Is it realistic for a social network occupying a single building?

Facebook is not alone. A number of other social media firms, such as Twitter, LinkedIn, Zynga and Groupon, are also valued in the billions. It’s true that they have built a vast community of committed users – with half a billion users of Facebook, 200 million “twitters” and 80 million users of LinkedIn.

The prevailing wisdom is that money from advertising will naturally flow from the large user base. LinkedIn has been successful in charging users for additional information on other users while Groupon gets a cut of each deal that its users buy, but Facebook, Twitter, Zynga and other sites rely on advertising that is more difficult to properly customize. In fact little is actually known about the sales and profits of the social networking companies as they are still private and don’t have to issue public financial statements.

According to media reports, Facebook generated about $2 billion in revenue in 2010, and so the $50 billion valuation means investors have awarded it a multiple of 25 times sales, compared with a nine-times multiple for Google, and Amazon's 2.5-times multiple. Facebook generates $4 per user, compared with Google's $24 per user and Yahoo's $8 per user, according to a recent report by JPMorgan.

Advertisers say there’s currently not enough advertising to go around and even if there was, why market to a mostly young audience that thinks you’re stepping on their personal conversations?

Apart from the threat that new technologies or rivals may easily replace the existing social networking business models, the big issue which may lead to bursting of the bubble is exactly privacy. As Scott Cleland puts it: “Simply what fuels Bubble 2.0 is the patently false core assumption that the current unfettered, widespread, and largely clandestine data mining of individuals private information in order to target specific individuals with personalized online advertising is aligned with real user interests; is a forthright business practice consumers are aware of and have meaningfully consented to; will not be legally constrained in the future; and will become the accepted norm. The holy grail here that has everybody so excited in the online-ad industry is that they understand that the more private details they can secretly learn about an individual user, they have a vastly higher chance of influencing them to do what they want them to do”.

And the new data privacy rules are already coming. Social-networking sites such as Facebook, or search engines such as Google, may face court action if they fail to obey planned EU data privacy rules. The European Commission wants to force companies to allow Internet users to withdraw any data held by the websites, calling it the "right to be forgotten," as well as make the firms provide more information on what data is collected and for what purpose.