The development of e-commerce has seen some huge peaks and troughs. In its infancy, e-commerce experienced a significant speculative boom lasting from 1995 to 2000, when global stock markets saw their values rocket on the founding of thousands of Internet-based businesses referred to as ‘dot-coms’. On March 10, 2000, the technology dominated NASDAQ Composite index, peaked at 5,048.62, more than double its value just a year before previously. Investors began to doubt the credibility of many of the business models. The financial magazine Barron’s shocked the market with a cover story “Burning Up” which highlighted the fact that America’s 371 publicly traded Internet companies had grown to the point, where they were collectively valued at $1.3 trillion, amounting to about 8% of the entire U.S. stock market, yet many had never made a net profit.

By 2001, the bubble was deflating at full speed and between March 2000 and October 2002, the crash wiped out $5 trillion in the market valuations of technology companies. It is hardly surprising, therefore, that investors have been far more circumspect since that period when valuing internet businesses and wary of putting cash into unproven firms. However, there appears to be foundations of a new high technology bubble developing in two sectors: social networks and online media.

At the start of February 2011, the Huffington Post was acquired by AOL for a stunning $315m. LinkedIn, the first major US social network to go public, saw its valuation rocket to $8.5bn after its flotation on the New York stock exchange in May 2011 – $5bn higher than anticipated. In November, Groupon, the discount voucher company raised $700m in an initial public offering (IPO) that valued the business at $12bn, ranking Groupon as the largest internet IPO since Google raised $1.7bn in 2004, although its value dropped after a surprise loss in the fourth quarter. In December, Zynga the online games maker behind Mafia Wars and FarmVille, priced its initial public offering (IPO) of 100 million shares at $10 a share, valuing the company at about $9bn.

A number of high profile internet groups are tipped to brave the stock market in 2012. Yelp, a review site for social networks has filed float documents and Tumblr, a blogging and social network site and Dropbox, the digital storing service are tipped for huge flotations.

So this leaves the two giants of the social media; Facebook and Twitter, both of which appear to be preparing for flotation. Sharespost, the ghost-trading site for private companies, recently gave Facebook a valuation of $82.9bn. This raises the question of how such a value can be attributed to Facebook, or any internet business where little reliance can be placed on historic data and where much of the asset base appears to be intangible. Traditional valuation methods are often difficult to apply. Investment values always eventually revert to a fundamental level based on cash flows. Most dot-coms, such as Amazon, do not have a positive cash flow and they bank on the future and the future is subjective, not objective.

Ultimately, the drivers of value creation are the potential revenue of a business and its ability to convert that revenue into cash flow for shareholders—an ability best measured by its long-term return on invested capital. In the business-to-consumer (B2C) market, firms must collect their revenue either from consumers or from other businesses that use their sites to reach consumers.

With Facebook, investors will buy size and dominance with 600m members worldwide; more than 60% of all web users. Sooner or later, most of the world’s sites will be connected to one or more of Facebook’s services. While the average online newspaper is viewed about 30 minutes per month users spend 12 times more on Facebook. Globally, social networks represent about 10% of the total internet time; and 2/3 of the internet population visit one such network at least once a month. And the growth is about 30% per year; in three years. Facebook looks relatively cheap, especially since it is now profitable. On the operational side, Facebook’s ARPU (Average Revenue Per User) remains at around $3 per year and per member, quite high by internet standards. However, the commercialisation of Facebook, though pleasing to potential investors is likely to alienate its members.

Twitter’s ARPU is about one tenth of Facebook’s, but the micro-blogging service carries a stunning valuation. If Facebook and Google are indeed about to wage a bidding war for the little bird and willing to cough up $8bn to $10bn, it could put a valuation of $50 to $60 on each of its 160m members Twitter’s simple, yet extremely powerful medium, could be a natural fit for Facebook and, to a lesser extent, for Google.

What is evident is that continual innovation in the technology market and an inability to predict consumer behaviour will ensure that volatility and risk remain important parts of the dot-com landscape.

IB-style questions

1. Define the following terms:

  • e-commerce
  • investment

2. Explain the concept of revenue and comment on possible sources of revenue for Facebook.

3. Analyse the advantages and disadvantages of a flotation for an internet business such as Huffington Post.

4. Identify stakeholder groups in Facebook and then discuss possible areas of conflict between them and how these conflicts may be resolved.