Social media has made quite a splash, even in the world of ETFs. But is it deserved?
Indexers and ETP companies like to think so.
The Global X Social Media Index ETF (NasdaqGM: SOCL) already holds Facebook in its top 10 holdings, with over 8 percent of its portfolio dedicated to the social media giant.
Also, the Etracs Monthly Next Generation Internet ETN (NYSEArca: EIPO) and its double-exposure sibling the Etracs Monthly 2xLeveraged Next Generation Internet ETN (NYSEArca: EIPL) both have more than 9 percent allocated to Facebook and more than 10 percent in LinkedIn.
What’s more, in April, Nasdaq changed the “seasoning rules” for several of its indexes, dramatically shortening the time that companies have to be publicly listed before they are eligible for inclusion. The previous waiting period of two years—and one year for securities with market caps in the top 25 percent of the index—was cut to four months.
Nasdaq didn’t say it, but everybody sensed the change was all about Facebook’s IPO.
One thing is certain—the technology niche that was in its infancy five years ago is in the mainstream today. However, that doesn’t mean the future is uniformly bright for all companies, which begs the question, Will social media be profitable in the long run? And is it any good in an ETF wrapper?
After all, before investing, investors should understand how a firm makes money, and whether its source of revenue is sustainable.
This question plagues many social media companies, and makes investors like me wary about buying into social media stocks.
I don’t want to pick on Facebook, but its challenges illustrate my reservations perfectly.
Admittedly, Facebook enjoys several core strengths—chief among them is its large and dedicated user base. According to regulatory filings, the company had more than 800 million monthly active users as of Dec. 31, 2011, a year-to-year growth rate of 39 percent. In 2011, the company generated $3.7 billion in revenues with operating margins of 47 percent.
Facebook has had an impressive run, but the jury is still out on its long-term profitability.
Most of Facebook’s revenue comes from online advertising, which means Google is a competitor—and a tough one at that.
If Facebook can’t demonstrate that its ads are effective at creating revenue for companies that advertise on its platform, this revenue stream is likely to be jeopardized.
Disturbingly, some firms have already decided to pull the plug. Just before Facebook’s IPO, General Motors made its own judgment and stopped advertising, concluding that Facebook ads don’t sell cars. If more companies follow GM, Facebook will feel the pain.
The market has high growth expectations for Facebook—its price-to-earnings ratio is 80—and a decrease in ad sales would be particularly awkward.
To meet growth expectations, Facebook would have to ramp up its revenue. But rather than increasing the number of ads per page and annoy users, it could learn to diversify its revenue stream much in the same way LinkedIn has done.
After all, half of LinkedIn’s revenue comes from “Hiring Solutions,” which is also the company’s biggest growth opportunity.
Essentially what LinkedIn has set out to do is unify the fragmented hiring market for corporate recruiters.
For a fee, businesses are able to access a huge database of potential hires, which includes employed workers who aren’t actively looking for a new job but may be the most attractive candidates. This also allows the job search to be scaled globally to countries like India. Some have even described it as the “Bloomberg Terminal” for corporate human resources departments.
Although Facebook has made some efforts in diversifying its revenue stream, Facebook Chief Executive Mark Zuckerberg needs another “aha” moment to match what LinkedIn’s Chief Executive Jeff Weiner has been able to achieve; namely, make social media profitable in the long run.
So is investing in social media via ETFs a good idea? I’d say yes, particularly for those investors who don’t have a favorite pony to bet on.
But most importantly, index investing allows market players to easily diversify risk in a space that still carries significant uncertainty—as I have spelled out in this blog.
Undoubtedly more social media companies will go public in the future, and more ETFs will launch that track such companies.
But investors beware: Although social media companies such as Facebook are as well-known as McDonald’s and Apple, they’re still very young and their profitability is a lot less certain.