No Shortage of Social Media IPOs

Brittney Barrett |

Extreme market volatility prompted a brief lull in tech IPO’s earlier this year, but this month would suggest they're returning with a vengeance. Yelp and Zynga, two of the most anticipated social media IPOs of 2011, are preparing for their own debuts this week on the tail of Groupon’s initial public offering in early November. Groupon raised $700 million in spite of significant doubts about the company’s potential longevity, accounting methods and other challenges. The bullishness exhibited by investors, all too happy to ignore the structural challenges at play, seems to have encouraged other major tech outfits to go forward with their own IPOs.

Introducing the Yelp IPO

Yelp, the online personal review website that features more than 22 million reviews of businesses ranging from dentists and doctors to salons, restaurants and carpenters has been hotly anticipated by tech investors for months. The site has successfully put power in the hands of the consumers, who can now make more educated decisions about where they will bring their business than ever before. Yelp has been a sensation, as evidenced by the 61 million-plus unique visitors each month it claims in its most recent regulatory filing. The traffic and the site's popular smartphone application bode well for the company’s future success, but Yelp is just one among those announcing their IPOs. So for hungry tech investors, it’s not the only thing to snack on. With Zynga hot on its tail--scheduled for after Thanksgiving-- investors will have their choice in the coming months.

In terms of popularity, Yelp has no shortage of it, but the company has had consistent trouble actually turning its online reviews into profits. Yelp brought in $58.4 million in net revenue over the first nine-months of 2011, a significant jump from the same period in 2010 when revenue was $32.5 million. The numbers aren’t bad, but Yelp’s overhead, particularly their marketing costs and sales continue to leave the company in the red. Yelp posted an operating loss of $7.4 million in the nine months ending Sept. 30, but the gap seems to be closing, which could help investors be more forgiving. Yelp, which will trade under the symbol YELP, submitted a filing to the U.S. Securities & Exchange Commission to raise $100 million, on Nov. 17. The company may be looking to debut while investors are still willing to scramble for ownership over a company with negative earnings, planning their IPO for Q1, 2012, according to the Wall Street Journal.

If earnings for Angie’s List (ANGI) and Groupon (GRPN)--both still unprofitable--continue to struggle in spite of going public, it could challenge the offerings of the companies in similar financial situations that follow them.

In spite of its lack of profitability, the Wall Street Journal reported earlier this month that Yelp was planning an IPO that could value the company at as much as $2 billion.

Perhaps with the help of new Chief Executive, Rob Krolik,  former CFO of Move.com, Yelp's earnings could meet such lofty expectations. Krolik, who was brought on after it was determined a new CEO would be needed to take Yelp public, has IPO experience from taking Shopping.com public and selling it to eBay (EBAY). Krolick has his work cut out of him. While Yelp is an objectively excellent concept, the company itself has struggled to make money when its user-generated content can be viewed for free. If Yelp doesn't find a way to boost advertising or other types of revenues it could be dangerous, but in all likelihood investors will be willing to bet that Yelp will find that necessary solution once the IPO debuts.

So for investors, would the better bet be on a company that has not yet generated profits or one that has, but has endured a massive decline in net income--like Zynga?

Yelp Versus Zynga

Zynga, the online game company that operated viral hits such as FarmVille and MafiaWars, is offering something that is oddly unique to the current social media IPO landscape: profits. Zynga took in $306.8 million in revenue for the quarter ending Sept. 30,  crediting advertising and the sale of virtual goods. The revenue growth, up from $170.7 million in the same period last year, bodes well for Zynga, but the company has seen an increasingly leaner harvest when it comes to profits.

Net income declined by 54 percent to $12.5 million in the third quarter, compared with the $27 million from the same period a year ago. While the profit losses will make some investors nervous, much of declines can be associated with aggressive development costs.

The future of Zynga relies on whether the company will be able to debut a new major hit and recoup capital it has put into developing new games. Diversifying its game portfolio will help minimize the financial impact of the options that don’t do well, which is probably  a necessary part of the strategy for a public company. Even with profits declining amid the attempts at diversification, Zynga may appeal to investors who will be more comfortable taking a stake in a corporation that has been successful in generating profits than one like Yelp, that after seven years, has yet to do so.

Zynga's history of success within the social media realm (the company has developed two of the top 10 Facebook games, with FarmVille occupying the top spot) may be enough to distract investors from the complications they are currently facing. Among the challenges Zynga is contending with, is an excessive reliance on the Facebook platform, competition from EA games and negative press from a recent decision to reclaim shares given to early employees leading up to the IPO.

The first of the obstacles will have a larger, and longer-term impact than the latter. Facebook requires that all of the games operated by Zynga use the Facebook currency and that a hefty percentage of the profits generated from the sales of online goods go back to Facebook. Zynga is doing its best to minimize its reliance on the platform as a result, but FarmVille's visibility on the frequently visited, Facebook profile could be seen as one of the main drivers of engagement.

Another potential challenge in Zynga reclaiming profits is the arrival of Electronic Arts Inc. (ERTS) in the social media space. EA is looking to increase their presence by transitioning a number of its console options into the social media world, as it did with Simms for Facebook. The early success of Simms could be taken as a direct threat to Zynga, as it threatens to eat into some of the market share.

The final challenge which Zynga will have to overcome when it goes public around Thanksgiving is a vaguely unfavorable portrayal in the media. The decision for the company to demand that early employees return their shares, became the focus of several pieces about Silicon Valley greed that painted the company in a negative light.

There's Always the Social Media ETF

For investors looking to invest in social media companies but can’t seem to choose from the bevy of options debuting this month, there is a third option. The Social Media ETF Global X (SOCL) that launched six days ago has been a major focus of media attention. The ETF was created with the intention of offering investors the opportunity to gain exposure to the broader social media segment without having to commit to one company.

The ETF has undergone harsh criticism for its basket of holdings, many of which are Chinese companies. While some investors remain bullish on Chinese internet companies, accounting disputes and the nation’s strict internet firewall have caused others to question whether these companies make good investments. SOCL did not seem to pay credence to the changing attitudes toward these companies, with its three largest holdings (each accounting for 10 percent of the fund) being Sina (SINA), Netease.com (NTES), and Tencent Holdings (TCEHY).

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
ANGI Angie\'s List Inc. 10.14 -0.11 -1.05 1,925
EBAY eBay Inc. 31.90 -0.17 -0.53 88,400
GRPN Groupon Inc. 5.32 0.00 0.00 103,773
NTES NetEase Inc. 240.25 -7.17 -2.90 118,138
SINA Sina Corporation 73.36 -3.28 -4.28 155,436
YELP Yelp Inc. Class A 38.84 -0.54 -1.37 90,285

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