Sites Like Groupon and Facebook Disappoint Investors

Just a year ago, social media seemed the next big thing. With dizzying user growth at Twitter, Zynga and especially Facebook, investors were euphoric about Internet sites that connected people with shared interests and experiences, seemingly the perfect media for targeted advertising.

The professional networking and job search site LinkedIn was first to test the public’s appetite when it went public in May 2011. Its shares more than doubled to close at $94.25 after trading as high as $122.70 that first day.

Early investors were understandably giddy, but others, like the former Treasury secretary Lawrence H. Summers, sounded a cautionary note. “Who could have imagined that the concern with respect to any American financial asset, just two years after the crisis, would be a bubble?” Mr. Summers asked at the time. Over the last year, Internet companies like Groupon, Zynga and Yelp made their public debuts. Facebook followed in May at $38 a share, instantly giving the newly minted public company a valuation of nearly $105 billion. Since then, euphoria has given way to mounting anxiety.

Facebook hasn’t closed above $38 since. The initial offering was widely deemed a debacle both for trading glitches and for the need for underwriters to prop up the stock.

The shares’ subsequent decline accelerated after the company’s first earnings report as a public company late last month dashed investors’ hopes for torrid growth.

This week was the end of the lockup period, which barred insiders from immediately selling their shares, and Facebook shares hit a new low, slumping to $19.05.

Other Internet companies have fared even worse.

Like Facebook, the Internet discount coupon site Groupon increased its offering price and number of shares just before its public debut last November. After rejecting a $6 billion takeover bid from Google in December 2010, Groupon shares closed at $26.11 on its first day of trading, up from its $20 offering price, giving it a market value of $13 billion.

It has been pretty much downhill ever since. On Friday, Groupon shares fell to $4.75, a decline of more than 75 percent from its offering price, giving it a market capitalization of just over $3 billion, barely half what Google offered.

Zynga, a company that makes online social games, went public in December at $10 and dropped 5 percent its first day. Although it traded above $14 a share as recently as March, it ended the week at $3, down 70 percent.

Shares of even the best-performing social media sites have stagnated. Yelp’s shares, which jumped 64 percent on their first day of trading in March to close at $23, were below $22 this week. And LinkedIn, considered by many to be the gold standard for social media concerns, never again hit its opening peak, and ended the week below $102.

Twitter and LivingSocial have put the brakes on going public; the companies have recently said they’re in no rush. That’s hardly surprising.

What went wrong?

Every company has its own story, but the euphoria over social media companies as a group was rooted in what economists call the network effect. The more users a site attracts, the more others will want to use it, which creates a natural monopoly and a magnet for advertisers.

Facebook has been a classic example. If your friends, colleagues or classmates are all on it, you’re all but compelled to join. But evidence that the network effect is working requires rapid growth in users and revenue, especially during the early stages of a company’s public life. So far, social media has failed to deliver the kind of growth that would bolster investor optimism, let alone euphoria.

The network effect is a double-edged sword, Ken Sena, a consumer Internet analyst at Evercore, told me this week.

“The network effect allowed these companies to grow so fast, but the decline can be just as ferocious,” Mr. Sena said. “If any of them misstep with users, they can leave, and the network effect goes into reverse.” The textbook case is Myspace, once the most visited social networking site, that is now a shadow of its former self.

This week’s Groupon earnings illustrated the problem for social media companies. In theory, Groupon should benefit from the network effect. The more users it attracts, the more merchants will want to offer coupons through Groupon, and vice versa. And on the face of it, the earnings report looked good. Groupon earned a profit of $28.4 million for the quarter, above analysts’ expectations, reversing a loss a year ago. Groupon’s boyish-looking chief executive, Andrew Mason, called it a “solid quarter.”