Archive for 9th August 2007

Proof of a Bubble: Success of Myspace is Pretty Overrated

How much yearly profit would you expect from a $500 million purchase? How about a profit of just $10 million equating to a profit margin just under 2%. That’s right, the world’s largest social networking site, constantly in the top 10 web sites in the world, managed to make only $10 million on $550 million in revenue!

I’m not an expert, but a 1.9% margin is pretty low. For example, the average profit margin for a company in the technology sector is currently 14%. It’s insane to think Myspace is worth “20 billion.” Even at a billion dollar valuation and revenue increased five fold, it would take 20 years to repay the purchase price while assuming social networking stays hot the entire time!

The most important distinction to make is that Myspace is in the notoriously fickle and very untested social networking market. It must recruit a completely fresh batch of users every few years as people grow older and move on. It must fight against social stigmas that come from the younger generations that might sound something like, “Ew, Myspace? My mom is on there.” For all we know, social networking as we know it may fade out of prominence in the next three years. Or even more likely is that another new competitor will eat into Myspace and take away its page views.

I have been observing signs of a significant bubble re-emerging, and this is the straw the breaks the camel’s back. Worse yet, when professional analysts throw out insane multi-billion dollar valuations on Myspace without sound financial reasoning, it’s time to be scared. Valuations are always relative, but I disagree with this valuation without having access to some more impressive metrics. Myspace is already at the top of the web — it doesn’t have opportunities to grow 1000% in the next few years.

Let me frame this in a more understandable way, if I told you this blog makes $200 a year in profit, would you be willing to buy it for $10,000? That’s the same ratios used assuming Myspace’s original valuation ($580M). But if Myspace is worth a little more than $5 billion as some people seem to believe, it would be like selling this blog for $100,000 on the $200 a year profit. Granted, maybe you could improve the profit margins by a factor of ten to $2000 a year (20% margins) — good luck.

Doesn’t seem like such a sound investment now, does it? The top social networking site in the world is barely profitable and there’s talks of it being worth 20x its purchase price. There’s a bubble, folks.