The birth of a new technological bubble: the social bubble

Doubts are rising about the effectiveness of advertising on Facebook, fueling a drop in Facebook stock prices just months after its stock market launch. At the time of Facebook’s IPO (Initial Public Offering), many thought share prices were overinflated with respect to their true value. When Facebook made its debut on Nasdaq, its value reached 104 billion dollars. A few months later, and despite a capital inflow of 12 billion dollars, that value has dropped to 47 billion. For shareholders, this means the initial share price of 38 dollars has dropped to 22, after peaking at 45 dollars per share.

Infographic on the dot-com bubble [Photo: GDS Infographics on Flickr]

Facebook has more than 400 million active users – its potential as a channel to reach a large audience is therefore unmistakable.  However, markets have become shifty since a number of big advertisers, such as General Motors, announced they would no longer be investing in paid advertising on the social network. These doubts on the effectiveness of Facebook ads have similarly shaken market faith in Facebook’s capacity to generate income to the tune of its stock market value.

Facebook is but one example in the wave of social networks steadily losing stock market value. Few networks have been able to avoid the downward spiral; one which has escaped is LinkedIn, which has seen its stock price increase by 66% since January.

Clearly, social networks do have the potential to make money, and success stories abound. However, it is still unclear whether they can pull off similar results on the stock exchange. Some experts are now warning that a new dot-com bubble may be growing around the social networks, similar to the one that burst at the beginning of this century. That bubble was inflated by unfettered enthusiasm about the success of internet-based companies, as well as by eager speculation by venture capital firms, which saw a chance to generate profits based primarily on prospects and valuation rather than on true profitability. These two factors led to unseen growth in share prices for Nasdaq-listed companies.

However, in time, it became apparent that some of the companies could not live up to the high expectations. This was rapidly reflected on the trading floor: the capital flight sparked by the first failures led to collapsing share values, causing billion-dollar losses. The bubble had burst.

New bubble in sight?

Many had warned that the stock market value of virtual world companies was highly exaggerated due to speculative trading. The market itself took care of correcting these discrepancies, bringing share values back to real-world levels. After the bubble burst, in 2001, almost 5000 of these virtual firms either disappeared or were absorbed; only the ones which were truly profitable outside the financial markets survived – for example, Amazon, Ebay and Yahoo.

Facebook’s IPO day [Photo: clasesdeperiodismo on Flickr]

It would not be a stretch to draw parallels between the situation of little more than a decade ago and the stock market fate of the majority of the social networks today. Although many of the elements which caused the first bubble to burst have been corrected (companies are better organized, have sustainable growth trajectories and realistic payback periods for investments …), some are far from gone, such as the voracious appetite for speculation. Describing the social networks’ stock market evolution as the next dot com bubble has become fairly commonplace.

Following the evidence of the 1997-2001 bubble, it is highly likely that the market will again take matters into its own hands, readjusting share prices and putting speculators in their place. The companies which are able to generate true value will remain on the trading floor. The problem is that most speculators will not be surprised by these market adjustments, seeing as the euphoria produced by speculative share price increases makes it exceedingly easy to sell the shares on to other investors – who are less well-informed, and therefore less prudent.

Translation of the original article in Spanish by Marie Vandendriessche.

This is a nonprofit explanation.

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