Embracing Hype?

From aiCIO Magazine's February Issue: Is the Facebook IPO evidence of a technology bubble?

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Facebook’s initial public offering may exude appeal for institutional investors eager to get into the technology sector, but, with the tech bubble all too fresh in many investor minds, many remain skeptical.

The world’s biggest social networking service filed in early February to raise as much as $5 billion in the largest Internet IPO to date, with the deal valuing the entire enterprise at between $75 and $100 billion. While technology analysts predict Facebook’s growth potential to surpass that of Microsoft Corp., the company has not yet proved its growth path to investors, analysts say.

To some, Facebook is expected to be one of the most profitable companies in the country, with almost twice the market capitalization of Goldman Sachs, ranking the Internet firm as one of the top 10 most profitable firms in the country—a very big bet to take.

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“Investors have yet to do all their homework—Facebook has to hugely expand its profits to make sure that its market cap makes sense,” says Dean Baker, co-director of the Center for Economic and Policy Research in Washington. “This is not to say that it’s impossible, but Facebook really needs to have a very large amount of revenue through advertising, which they don’t have yet.”

The big question, according to sources evaluating the tech giant’s true worth, is whether the firm’s treasure trove of information—in the form of “Likes”, photos, and Wall posts—has the potential to be quantitatively better than what advertisers already have, and whether the company will be able to effectively capitalize on that. So is the hype surrounding Facebook a possible sign of the next tech bubble?

Sources say the skepticism surrounding Facebook’s worth sheds light on the perceived risks of the technology sector, with the tech blowups of the past having made investors somewhat wary of embracing Facebook and other technology companies too rapidly.

Take the example of Pets.com, one of the many examples of a high profile public failure during the dot-com bubble in the early 2000s. Without a workable business plan, the site lacked a substantial market niche and was unable to raise sufficient capital, falling from over $11 per share in February 2000 to less than $0.20 the day its liquidation was announced. Or look at a recent example, Groupon.com, a deal-of-the-day website that features discounted gift certificates. In October 2011, a report from Forrester Research hinted that the firm’s business model was a “disaster,” noting that the company had become an example of “how fast an Internet darling can fall.”

The market has clearly fallen in love with new and exciting tech companies, thinking they’ll all be the next Google. “Institutional investors are going to make the same mistake they did a decade ago,” Baker warns. “Is there another Google out there? There may well be, but there are a lot of cases where people aren’t doing the homework they should in new technology.”