Alex Brummer

Investment Special: The social network bubble

Are investors repeating the mistakes of the dotcom era?

Investment Special: The social network bubble
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It’s an irritating daily occurrence. The names of two or three people I barely know pop up in my inbox asking me to join their ‘professional network’, LinkedIn. Early on, I was tempted by the idea that being part of this family might widen my range of contacts, and perhaps also my story-gathering capacity. But then I realised that anything that had grown so big and amorphous was hardly likely to be a source of exclusive information.

Nevertheless, social networks from LinkedIn to Facebook are the new investment fad. Having been wrong about Google when it first floated — my view was that legal disputes over content meant that it could never work — I hesitate to be dismissive about the current generation of tech giants.

The movie The Social Network has redoubled the fame of Facebook and its co-founder Mark Zuckerberg. The power of social media has been displayed both in the Arab Awakening and in our own August riots. Shares in Facebook have already been distributed among favoured Goldman Sachs investors, even though it is not planning to come to market until early next year. Reports suggest that even though subscriber numbers may be flatlining, Facebook could  be valued at close to $100 billion.

Another star of today’s cyber-universe is Reid Hoffman, the former Apple and PayPal executive who launched LinkedIn from his living room eight years ago with 350 personal contacts. Now it has 90 million users. When it floated in May, pundits said its value would be around $3 billion. But in an astonishing first day’s trading, the market valued it at $9 billion, raising memories of the tech bubble of 2000. This was the first social networking site to test the public markets and the result has changed perceptions of their potential worth.

Backers of LinkedIn include 55-year-old Cardiff-born Michael Moritz of Sequoia Capital, whose California-based venture fund was a pioneer investor and who sits on the group’s board. Moritz was also a founder investor in Google, where Sequoia’s initial $12.5 million stake is now thought to be worth billions.

Fortune magazine estimates Moritz’s personal net worth at $1.5 billion; he has served on the boards of a series of cyber pioneers, including Flextronics, Yahoo! and PayPal.

One of the great complaints about the British economy in recent times has been its failure to create tech champions on its own soil. The achievements of Moritz and Jonathan Ive, the British-born head of design at Apple, are well documented. But amid the market turmoil of August there was a sharp reminder that there is still value in the UK high-tech sector. Cambridge-based Autonomy, the software firm created by former academic Mike Lynch, was snapped up by Hewlett-Packard for £7 billion amid much tooth-grinding over the selling off of another piece of British genius. But with a 70 per cent share-price premium on the table, it’s a hard offer for investors to resist.

Perhaps not surprisingly, a post-Autonomy glow has descended on a sector that had been treated with some caution over the past decade. Intellectual property and patents, high software content (like Autonomy), cloud computing (the next big thing) and vertical integration (Google’s purchase of Motorola’s mobile devices division) are all seen as promising themes in the merger and acquisition arena. Favoured UK firms include innovative chip designer ARM. Also worth watching is Imagination Technologies (which I hold) where the upside is exposure to Apple — though anyone worried about loss of creativity in a post-Steve Jobs Apple might regard Imagination as vulnerable.

Elsewhere, among recent online pioneers to test the investment waters is the social-network game developer Zygna, inventor of the fashionable Facebook games FarmVille and Mafia Wars. Founded in San Francisco in 2007 by Mark Pincus, with $29 million of venture backing, it started its rush to market in July with a prospectus offering three classes of shares — a structure designed to keep Pincus in the driving seat. Zygna was being valued at anything up to $20 billion, but aspects of the prospectus provoked criticism and the float has been delayed by a dispute with the Securities and Exchange Commission over the way the company books revenues.

Another major internet float to surface recently is Groupon, a website which features discounted deals and gifts, founded in 2008 by Pittsburgh native Andrew Mason. By June this year the company had signed up 83 million subscribers worldwide, was offering 1,000 deals a day and was being valued by the market at up to $15 billion.

This surge in valuations of a new generation of business, social and gaming network sites has raised concerns that the online world is repeating the mistakes of a decade ago, when the fashion for dotcoms exploded in the face of investors. Not all social networks stand the test of time. Just ask Rupert Murdoch, who bought MySpace for $580 million six years ago and sold it for $35 million this year. Pursuing the next big cyber idea is one of the most dangerous games in investing. But for those who get the timing right, there is still fabulous wealth to be created.

Alex Brummer is City editor of the Daily Mail.