A Fresh Look at What’sHappening in the High-Tech

and Social Media World

by Patricio O’Gorman | @patoguru

# 004 | July 2011

Valuation seems to be the word á la

mode for social media companies. As if we were back in the dot com boom, theheydays of pets.com and webvan.com on one side, and Yahoo and Amazon on theother - to name but a few of the web “valuation giants” - social media companies fightto see which one is worth more than the rest. The days of talking about millions ofusers seem to have given way to a much more intense conversation about money.And, as we all know, whenever we discuss money, Wall Street can’t be too far behind.In the case of social media, however, there is not only Wall Street but also privateinvestors, since most successful ventures are still private companies and as such, havenot opened their books to IPO world.

This fact I just mentioned actually makes comparisons very difficult, since youend up talking about Linkedin, who just IPO’d, and Facebook, who’s been about to IPOduring the past 3 years but still hasn’t. It certainly is much easier to discuss growthmetrics and finance on a public company, that has gone “on the record”, than talkabout Twitter’s strategy, when it’s still receiving private financing and there are dozensof speculative independent valuations found by just surfing the web.

. This issue of Tech inDIGESTion focuses on social media companies and theircomparability as far as valuations – public or private – allow us. I called it the “SocialMedia Index” for obvious reasons, and hope the readers validate it as a useful tool forbenchmarking existing or new ventures. In the end, the metrics I provide use “peruser” models and therefore I bring back to the attention of everyone just howimportant users/customers are to any company.

I still have in my files a very useful tool from HBS called Lifetime CustomerValue Calculator, which uses basic inputs such as the frequency of purchases, theaverage purchase, the retention rate and customer acquisition costs to determine thelifetime value of a customer. Such metric, even when the average discussion is veryoriented towards plain user statistics or in-the-air valuations, should be taken veryseriously because in the end it is how a company starts having a cash-flow.Constructing such a simple tool, however, becomes a near-impossible task when nocustomer information is available or the business model does not allow for clarityaround for building the individual valuables (such as retention rate, average purchase,etc.).

Technology InDIGESTion @patoguru #004 | July 2011

Technology InDIGESTion @patoguru #004 | July 2011

HIGH

LOW

LOW HIGH

.

In this valuation vs users two-by-two, you can see Facebook’s real strength: the basicnumbers. An extremely high adoption rate makes it the most popular social media site interms of users, and very solid in terms of private valuations (IPO seems more likely at thispoint, but used to be like expecting George Lucas to film the sequel to Return of the Jedi).It would be interesting to see whether other services obtaining more users follow thearrow above or if they move in another direction.

Valuation in M USD

Amount of users in M

Size equals amount of users

Company with highvaluation but few users

Company with lots of usersbut low valuation

Technology InDIGESTion @patoguru #004 | July 2011

.

Things look different when you mostly look at only money (valuation and revenue) –Facebook becomes “one of the bunch”, placed in the average category along with LinkedInand Skype. Groupon becomes the “money star”, ranking high on both categories. Twitterfalls way back, showing it has disproportionate amount of users for its capacity togenerate cash, being the lowest on ARPU (no info on 4Square). Skype’s relative high scoreor ARPU might be another insight into Microsoft’s purchase decision.

Average Revenue per User (ARPU – usd)

Average Value per User (AVPU – usd)

Size equals amount of users

HIGH

LOW

LOW HIGH

AVERAGEon both

categories

HIGH ARPU + HIGH AVPU

LOW ARPU + HIGH AVPU

LOW ARPU + LOW AVPU

HIGH ARPU + LOWAVPU

HIGH on bothcategories

LOW on bothcategories

Technology InDIGESTion @patoguru #001 | January 2011

Social media does not have its own rules.

After the dot-com bust we all learnt that the only rules that apply are the rules of thebusiness and that cash is still king, although some might think otherwise. Below is theSocial Media Index – an attempt to describe a mix of valuation (acting as expectationon performance) and revenue or cash generation (actual performance). It’s a sort ofMarket to Book ratio, in order to understand the viability of these companies. As thevariables move so will the index, and more companies will be added as they becomerepresentative for the social media world.

Technology InDIGESTion @patoguru #004 | July 2011

* AVPU = Average Valuation per User

ARPU = Average Revenue per User

A value of one means market valuation is in line with company revenues. Above means Market valueis a multiple of revenues, a below a fraction of revenues.

No revenue informationavailable.

Technology InDIGESTion @patoguru #001 | January 2011

To conclude, Social Media is leaving its

infancy, and “sort of” getting used to the general rules of business, which basically say thatyou need to generate enough cash to cover your expenses (e-tailers went through a similarprocess in 2002 onwards) and have a credible and expandable base of revenue per user(ARPU). Twitter is an example of a social media company looking for its destiny; it seems tobe very popular, with a large user base but after 5 years no clear business plan to generatecash without eroding its user base (who unfortunately for them are rebellious and got used toa free, hierarchy-lacking, no-ads, no-hassle service). However, and due to the way the SMI(Social Media Index) is calculated, it ranks first. It has a valuation 51x its revenues.

Facebook, second on the ranking with a 45x valuation-to-revenue multiple, has a differentchallenge. It is the poster child for social media, with a very successful movie made about it, ahigh-profile founder, a loyal user-base and a good ability to generate cash for itself and forpartners (Zynga, creating videogames for Facebook platform). What it should fear the most isbecoming a corporation: the Microsoft (Google?) syndrome: you start having Wall Streetearnings targets, you need to create a large bureaucracy in able to function in thatenvironment … and you lose that loving feeling about being the irreverent start-up. All of asudden you wake up and you are telling analyst why this or that company are not threat,while thinking you have become the incumbent and are being out-smarted by kids in a garagestay up all night waiting to put you out of business …

LinkedIn appears in third position and seems to have played its IPO nicely (first IPO’d companyin the ranking), keepings its expectations at 26x its revenues.

This is social media and it´s not a game to be played lightly. Privacy issues, technical mistakes,badly-adapted features are not easily forgiven or forgotten by users (if not, read anywhere onMySpace’s fall from 70M users and USD 580M to half the users and sold at USD 35M thismonth – would have a SMI below one!). Let this short note be a cautionary tale to companiesat both ends of the spectrum – the Twitter’s without a clear business model and theFacebook’s with a clear business model but fear of becoming old-school.

Lasting social media success, quite probably, lies somewhere in between. With everythingthat’s going on, I think we’ll soon find out!

I look forward to hearing your comments at technology.indigestion@gmail.com and continuethis conversation; or, we can also pick up via twitter @patoguru. Meanwhile, I hope this hashelped you partially digest this wonderful world of technology or, at least, given you somefood for thought.

Technology InDIGESTion @patoguru #004 | July 2011

Technology InDIGESTion @patoguru #001 | January 2011Technology InDIGESTion @patoguru #004 | July 2011

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