What 2014's Ugly Social Media Stock Performance Means for the Future

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With all the buzz around sky-high valuations for collaborative economy and messaging startups, you may have missed that publicly held social media stocks had a pretty terrible year in 2014. The 11 U.S. stocks in the social media industry--including those in categories such as social networks, ratings and reviews, community platforms, relationship and content management and collaborative economy--lost 19.2% compared to a NASDAQ increase of 14.31%. Of the eleven stocks, just one outperformed the market, only three gained in 2014 and half lost more than a quarter of their value.

Chart from Yahoo Finance

What does it mean that social media companies are sagging? The problem certainly is not stagnating adoption. Despite the negative press about teens and Facebook, the social network continued to add active users at a steady pace in 2014. Same with Twitter and LinkedIn. And a study by Localytics found that time spent with social media apps rose almost 50% between 2013 and 2014.

So if consumers are continuing to integrate social media behaviors into their lives, why are stock prices falling? The same reasons any stock falls:

• Investors were over-optimistic: Being too optimistic too quickly within a new category is what investors do. They did in the Web 1.0 era and now they are repeating the mistake in the Web 2.0 era. People seem to forget the past; for example, in the two years following the dot-com bubble burst in April 1999, Ebay lost over 60% of its value and Amazon fell over 90%, while at the same time, hundreds of other Internet firms failed outright. The decline in social media stock value was completely foreseeable--in fact, back in December 2011, I predicted a "slow motion social media valuation bubble burst" (although, to be fair, I also predicted Facebook's stock price would fall in 2014, and I didn't get that right.)
    
• Financial performance disappointed the market: Considering the amount of time people spend with social networking, you'd think making money would be easy. Turns out it is not. Just three of these 11 companies have a P/E ratio, because only three of them have any E. (That means, only three have earnings in the trailing twelve months--Facebook, HomeAway and Yelp.) Almost three-quarters of these companies are still trying to consistently remain profitable; for example, on a GAAP (Generally Accepted Accounting Principles) basis, Twitter continues to see consistent quarterly losses (although on a non-GAAP basis they have reported quarterly profits). While Groupon, LinkedIn, HomeAway and Yelp flirt with their break-even points, many social companies are nowhere near profitability--at the current rate, Jive may get into the black before the end of 2015, but the same cannot be said for Zynga, Bazaarvoice and Marketo, based on their recent quarterly earnings trends. Facebook is the only social media stock that has been able to demonstrate consistent and growing profitability as of yet. 

What does this mean for the future? I have several predictions: 

• Facebook's stock price will fall in 2015: I am nothing if not consistent--I was wrong with this prediction in the past year, but I think my error has more to do with timing than eventual outcome. My analysis of Facebook's strengths and weaknesses has not changed from twelve months ago. Facebook is reliant on a single revenue stream--ad dollars--and while ad revenue has been easy to grow in recent years as consumer time and marketer interest rose, both will hit their limits soon. This will likely cause Facebook's income growth to slow, which is a serious problem for a stock trading at a generous 74 P/E ratio. Facebook desperately needs diversified income sources, and it seems company leaders recognize this as an issue, as its last quarterly earnings report included a warning of rising costs as the social network strives to expand its business. To be clear, I remain bullish on Facebook's long-term opportunities, but just as Amazon and Ebay had to suffer through years of diminished stock prices as they built stable and diversified business models, so to will Facebook, I predict. (And if and when Facebook stock gets dented, watch for a domino effect to ripple through other social media stocks.)
   
• Don't expect a major turnaround in social media stock prices in 2015: I do not expect a significant bottom in social media stock prices this year, although some individual company shares may rise. I'm not alone in this forecast, of course; in July Oracle Chairman Jeffrey Henley said that the social and cloud markets felt "like the bubble 10 years, 15 years ago," that same month Federal Reserve Chair Janet Yellen shared that "some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries," successful market guru Doug Kass recently noted that "There are bubbles in social media stocks," and investment manager Rich Pzena, speaking about social media stocks three months ago, noted "We're getting out of the realm that makes any sense for a value investor... There's going to be more losers than winners." What will it take to cause social stocks to rise? More than a handful of quarters of consistent, rising revenue, increasing profitability, and stock prices that are sane multiples of earnings--and this may take years to accomplish.This probably means that...
    
• Some social media companies will fail: Pets.com was not a horrible idea--just ask PetSmart, which is aggressively growing its online presence and capabilities.  Neither were Flooz, Webvan or many other dot-com companies that flamed out because they were a bit too ahead of the curve. I don't expect all 11 of the companies in my social media portfolio to survive through the next two or three years. Airbnb is well on its way to pushing HomeAway to the curb, and Angie's List may find it difficult to survive in an age of free ratings-and-review sites. Some entire subcategories within the social media industry may simply not be sustainable--given declining organic engagement rates, low acquisition/conversion and the cost of creating content, it is possible marketers may ease or even reverse their trend toward social media marketing investment in the coming years, and that could decimate entire subcategories within the social vertical.
   
• Collaborative economy companies will do well in the long run, but the intermediate term will be rocky: The Internet era was won not by companies that relied on advertising (so long Excite, Prodigy, Alta Vista, etc.) but by companies that found new ways to empower digital consumers and companies (hello Amazon, Ebay, iTunes, Oracle, Salesforce, etc.) For this reason, I remain more bullish on companies that leverage consumers' newfound social and sharing behaviors more for commerce than for advertising. But, while collaborative transportation, lending and place-sharing have a rosy future, this year's valuations strike me as wildly optimistic. Uber, Airbnb and others face a host of challenges in the coming year, from improving safety to gaining consumer trust to serious legal and regulatory hurdles. Right now Uber's valuation stands at $40B, which is three to six times greater than Hertz and Avis and approaching that of Ford and General Motors. As we saw with Ebay and Amazon, innovative companies can win in the long run, but we should be cautious in expecting too much too quickly in terms of retention of customers, growth, stable expenses and consistent bottom-line performance.  

What do you think? Will 2015 be the year that social media stocks turn around, or do you agree that we may be years away from finding the right values for publicly held social media companies? 

Here is the data on the eleven companies in my social media stock portfolio. If you think I missed any, please let me know. I omitted companies that do not make all or most of their revenues from social business models (hence Google's omission) and any company that wasn't publicly held at the start of 2014 (HubSpot, which went public three months ago, will be added to the portfolio in 2015.)
  

2014 Social Media Stock Portfolio

		Close 1/2/2014	Close 12/31/2014	Change
Facebook	FB	54.71	78.02	42.6%
LinkedIn	LNKD	207.64	229.71	10.6%
Bazaarvoice	BV	7.77	8.04	3.5%
Marketo	MKTO	38.03	32.72	-14.0%
Yelp	YELP	67.92	54.73	-19.4%
HomeAway	AWAY	40.14	29.78	-25.8%
Groupon	GRPN	11.85	8.26	-30.3%
Zynga	ZNGA	3.95	2.66	-32.7%
Jive	JIVE	10.92	6.03	-44.8%
Twitter	TWTR	67.5	35.87	-46.9%
Angie's List	ANGI	13.58	6.23	-54.1%
	Mean	-19.2%
	Median	-25.8%