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LinkedIn is floating on air… or is that a bubble?

LinkedIn’s highly successful share market debut on Wall Street overnight will have no doubt delighted the social networking site’s founders and investors, with the stock’s price more than doubling during…

Is LinkIn’s successful float a harbinger of a looming tech bubble? AAP

LinkedIn’s highly successful share market debut on Wall Street overnight will have no doubt delighted the social networking site’s founders and investors, with the stock’s price more than doubling during its first day of trade.

But the fact the company’s market value consequently rocketed from $US3 billion to nearly $9billion in a matter of days will also add fuel to concerns that we are heading for another tech bubble.

LinkedIn’s listing is the first of a string of highly anticipated tech floats in the next 12 months, including an initial public offering (IPO) for Facebook.

If these companies go public with the same success as LinkedIn, then fears of the first tech bubble since the 1990s may well be justified.

Profit taking

One of the key reasons for a company to make an initial public offering (IPO) and list on the stock exchange is to raise capital.

The money received from the market in return for issuing common stock (shares) provides the corporation with the required resources to capitalise on market opportunities, generate revenues and earn sustainable economic returns for stakeholders.

For the individual investor, an IPO can present an attractive early opportunity to tap into a business venture with high potential for value creation, promising the shareholder a return on their investment greater than the risk-free market rate.

Well, that is the theory. But what are the risks?

The collapse of the dot-com bubble in 2000 and the ensuing dramatic decline in stock prices of internet companies, along problematic accounting practices and the fall out of the global financial crisis (GFC), have conspired to stem the appetite for risk among financial institutions and investors.

More recently, increasing investor awareness of risks associated with the new generation of high tech businesses, as well as the costs associated with running a public company, have translated into a depressed market for public offerings.

This is particularly true for IPOs of internet businesses, as it is often difficult even for experts to determine the real value of those companies.

Not surprisingly, investors are no longer prepared to invest purely on the bases of analyst opinions or financial reports.

When evaluating a company’s performance, they want to understand what is being measured, including sources of revenue, cash flow, core earnings and the value of any outstanding employee stock options.

In an uncertain economic environment, investors remain risk-averse and demand better information.

Trouble bubbling?

Despite global economic uncertainty, and in particular in the US, IPOs are coming back into favour again as alternative investment modes.

Reenergised by stock market activity, historic low interest rates, a depressed real estate market and an increasing number of Chinese technology companies seeking to list on the US, stock markets provide a rationale for this renewed level of interest.

Wall Street has also noted resurgence in high tech IPO offerings. This is particularly applies to a group of internet based ‘new economy companies’ that have high growth potential.

Some market analysts are concerned by this trend and caution that if large Web 2.0+ companies such as Twitter or Facebook decide to go public it will no doubt change the rules of the game for the industry.

Social network companies like Facebook (with an estimated value of $US79 billion) have a profitable business model and consequently have the potential to raise billions of dollars in an IPO.

This will certainly put pressure on others to follow and join the fray.

The $US8 billion price tag reportedly paid by Microsoft for Skype, and now LinkedIn’s successful IPO, has raised concerns among analyst in particular how a company like LinkedIn could be worth 36 times its revenues.

Reflecting on these recent transactions, some industry observers have speculated that there is a very real potential for the igniting another high tech bubble.

Staying positive

Not everyone will agree with these dire observations and some analyst argues that there is no internet bubble now, nor likely to be one.

Here, it is suggested that the potential for commercial revenue growth, particularly for social networking sites and companies like Facebook and LinkedIn, “have not even scratched the surface yet in terms of their potential to develop new markets and commercial opportunities”.

There is no doubting the fact that the current generation of internet-based, high-tech start up companies, unlike their predecessors, have spent more time and energy on developing viable business plans and growing their customer bases.

Facebook, for example, has a customer base of some 600 million accounts and earned $US355 million on revenue of $US1.2 billion.

LinkedIn and its founder Reid Hoffman, 43, who owns a 21% stake in the company, have spent over a decade developing their business.

Its customer base embraces 90 million people who have set up profiles on its website.

LinkedIn generates its $US180 million in revenue annually from a mix of online advertising and fees charged to businesses for expanded access to listings on their website and earned $US1.85 million during the first nine months of 2010.

There is however little doubt that these companies are more mature, have a superior business models and generate better revenues than their predecessors during the dot-com bubble.

Keeping cautious

For the present, institutional and private investors however remain very cautious.

Many of the internet based companies will first need to establish a track record for profitability to ensure a successful IPO.

There are many social sites and as time becomes more and more a scarce commodity, rationalisation will occur.

LinkedIn survived and outlasted an early generation of social networks because of its pragmatic approach and focus on their core business and commitment to developing and refining a sustainable business model.

This has made them an attractive investment for institutional shareholders.

In a converging landscape where the boundaries are collapsing between telecommunication carriers, software developers, device manufacturers and media there is little doubt that there will be a surge in IPOs, mergers and acquisitions and alliance activities.

There are signs indicating the potential for another tech bubble and dramatic fluctuations in the stock prices of internet high – tech companies and social networks are a real threat to the investors’ aspiration for wealth creation.