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Internet Investment Considerations: Groupon and Facebook

As new investment opportunities arise in the internet sector, several factors must be considered in the proper evaluation of these companies. Many parallels from the Internet bubble can be drawn, with slight differences. On the one hand, some companies are attempting to disguise their numbers with new fancy terms, in order to divert attention from the fundamentals. Yet, on the other hand we have a more mature internet than back in 2000, which can significantly influence the leader position strength in these current companies.

Groupon

No, ACSOI is not the new EBITDA circa 1999 Amazon. The reality is that businesses have to make money and Groupon has become an expert at burning cash, at a rate of $100 million last quarter. Despite being touted as the fastest growing company ever, there are serious flaws which make Groupon an extremely risky proposition.

First of all, their model requires a massive number of salespeople. Thus, in order to grow, Groupon has been hiring thousands of employees, pushing Groupon’s numbers further in the red. Then there’s the issue with entry barriers for competitors – there are none. Groupon’s service can be, and is being replicated by thousands of competitors eating away from Groupon’s market. Then there is Google and Facebook, which both are in more intimate positions with potential customers, which can serve as an incentive for these giants to enter Groupon’s turf. The lack of an entry barrier for competitors, and the astronomical valuation that the company currently has, makes Groupon a poor choice for an acquisition.

At this point, only a secret, innovative approach can save Groupon – and that is highly speculative. Even an alliance with one of the Internet giants is not enough to reverse the downward spiral that Groupon appears to be following. An alliance might just delay the process of failure, as was the case of MySpace when it signed with Google. It ultimately went under, once the Google contract had expired.

All in all, I see Groupon as a poor investment.

 

Facebook

With Facebook, there is something powerful that goes beyond any rational analysis that one could make – and that is their vast pool of talent. Back in the 90’s, Bill Gates was asked which competitor he was most afraid of. He said, Goldman Sachs. His logic was that there is a competition for talent and whoever attracts the most talent will be in a position for success. Facebook shines in their aggressive history of attracting talent from all the top companies.

Talent together with the enormous power held from their network effect is a combination which could yield many good results. Unlike MySpace, which was the first social network to capture mainstream, Facebook is growing roots, deep roots within the Internet fiber, which places the company in a unique and monopolistic position of controlling the social layer of the internet.

This control of the social layer is the single most valuable asset the company currently has, and much consideration must be given to their capacity to retain control of it. In order to determine whether Facebook is a good long term investment, there must be an understanding of how well and for how long Facebook can control the social layer. There are various ways to see the evolution of the web, which can draw some possible outcomes. In a recent paper, I proposed one possible outcome which predicts that control of the social layer will cease, and an open format will come as a replacement:

“Facebook has done the job of transitioning the social layer element of the Internet and as history shows, we will eventually come out into the open web again. Instead of logging into Facebook, the social layer will permeate throughout the whole web – think “like” buttons. Instead of a singular social place, the entire web will be social and the social intelligence will be distributed – think Diaspora. The social component will feel natural to the average user because of their experience with the closed Facebook system, and the user will easily navigate and interact with this new integrated component.”

It is my opinion that a transition to an open format will occur. However, it is too early to predict when this will happen. Attempts like Diaspora have gained little traction and Google+, despite its stellar opening is losing steam as well. Thus, the timing for Facebook might be just right.

Given the uncertainty of the above, there is still relative calm in the medium term future for Facebook’s control. Facebook still has the talent, and they are still growing at a healthy rate. In terms of monetization, they have much room for growth and their Facebook Credits can be a formidable source of revenue. Ad targeting is generating significant revenue, and I see room for improving and expanding on this segment also.

Finally, there is the basic consideration of psychology. Never in the world has a company touched so closely the lives of so many people. Facebook has connected the world, and many individuals will certainly be very interested in buying a piece of stock. Average Joe’s won’t think twice about Facebook’s market cap, rather they will just buy. In this frenzy, I cannot help but think that those who entered early through SecondMarket will stand to reap many profits from their investments. Facebook’s valuation at their IPO will most likely be comparative to Palm’s IPO launch.

Facebook stock at current $80 billion appears to be a good investment, given the quick pop potential it has on its IPO mania. Obviously, more consideration must be given on the long term viability once their numbers are out. However, given that Google extracts much of its revenue from a very similar model (contextual advertising), and Facebook has captured much of the web’s traffic, it can be reasonable to assume that Facebook could sustain a valuation close to Google’s current $160 billion.

*This article is not financial advice, nor is intended to recommend the purchase or sale of any stock or investment. Please consult your financial advisor for investment guidance.

 

 

 

Categories: English Tags: , ,
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  1. November 4, 2011 at 9:14 am

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