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Tuesday, August 28, 2012

Investing in Buzz Is a Loser's Game

Posted By on Tue, Aug 28, 2012 at 11:20 AM

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There will likely never again be anything like the dotcom boom-and-bust of the late '90s. But that doesn't mean that everybody learned their lesson about investing in companies with questionable business models -- or at least in those with outsized expectations for growth. It only means that the economics have changed, along with the business landscape.

There are far fewer companies going public, but there are still lots of suckers out there who invest in "technology" companies (even when they aren't really technology companies) because that's where the buzz is.

Back then, companies went public every day, in droves. Many of them were dumb on the face of it -- Pets.com is perhaps the most-cited example, thanks in large part to its marketing excesses and the fact that it was liquidated 268 days after its IPO. The lesson should have been that public markets should be reserved for companies that have a reasonably secure future.

Tell that to the investors that have been hosed on the initial public offerings of such dogs as Facebook, Zynga, Groupon, and Demand Media. Not that they deserve sympathy -- they invested based on "buzz" and not much else. And they deserve what they get (just as they'd deserve it if somehow the stocks took off.)

Indeed, so numerous are buzz investors that, given the relative dearth of choices, that much more money is poured into the few dogs that do make it to market. And predictably, that money often quickly vanishes as reality sinks in.

Facebook hit the market in May at $38 and the trend has been inexorably downward ever since. On Tuesday, the shares were trading at about $19. It turns out that cheesy, almost spam-level ads don't make for a great business model, even if Facebook's boast of having nearly a billion active users is accurate -- which it isn't. Was all this known before Facebook went public? Sure it was.

The fate of Zynga -- the company responsible for such atrocities as FarmVille and CityVille -- has seen its stock decline from $9.50 at its December IPO to about $3 now. Its fate is somewhat tied up with Facebook's -- Zynga supplies Facebook with about 12 percent of the latter 's revenue (for example, from people actually spending real money on pitchforks or fertilizer or whatever for their virtual farms).

Some tech bloggers and journalists went ape over Groupon before it went public. I never understood why. It's online coupons, right? And Groupon takes a cut of the already discounted price, leaving businesses that participate with a net loss on each transaction? Yeah, came the reply, but this gets people to try the tanning salon or the local diner and then decide they like it so much they come back again and again. It's a loss leader. Turns out that too often, it's merely a loss. Groupon started trading in November at about $26. It was trading on Monday at around $4.40, on an up day.

When it went public in February 2011, Demand Media was in the garbage business. It paid inexperienced writers pittances and dumped the resulting nonsense onto the Internet in vast, putrid heaps. It was basically a content spammer (or "article marketer" as the sleazebag jargon has it.) Just a month after the IPO, Google tweaked its search algorithm, upon which Demand was heavily reliant, to ratchet such substandard content further down in the results (shareholder lawsuits allege the company knew or should have known this would happen). Demand is rejiggering its business now, and its eHow and LiveStrong sites actually seem to be improving. The company even eked out a tiny profit in its latest quarter -- less than $100,000. But should it ever have gone public to begin with? No, of course not.

There are some relative successes. Despite its shaky business model, online radio company Pandora's stock is holding up fairly well. Analysts even expect it to report a small profit in its current quarter. And shares of the career-focused social network LinkedIn are actually trading higher than when the company went public in May 2011.

What's most striking about all these companies is that none is really a technology company, though they are all characterized as such (which serves the interests of stock peddlers, who do a lot of the characterizing). Intel is a technology company. Cisco is a technology company. These Internet outfits all use technology, but their businesses are driven largely by "attention," which is amorphous and unpredictable. And "attention" is the real reason that not a few investors are willing to plunk down money on them rather than on something more reliable and less risky.

Dan Mitchell has written for Fortune, the New York Times, Slate, Wired, National Public Radio, the Chicago Tribune, and many others.

Follow us on Twitter at @TheSnitchSF and @SFWeekly

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Dan Mitchell

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