Can You Play These Social Media & Gaming Stocks for Profits?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Social media stocks are something of a conundrum. Many of them are expensive, and some of them have not demonstrated that they even have a chance of justifying their high valuations.

Good News for Social Media Stocks

Many of these stocks have reported positive events and financial results. For example, LinkedIn (NYSE: LNKD) reported fourth-quarter results above analysts’ estimates that surged to a record after increased membership. The company’s revenues increased by 81% to $303.6 million. According to the data compiled by Bloomberg, the average analyst expected revenues of $279.7 million. The company’s profit excluding certain items was 35 cents a share, topping the average 19-cent projection. The advertisers who visited the company’s website increasing its user’s base by 8% to 202 million.

Other stocks are trying to recover from problems. Electronic Arts and Zynga (NASDAQ: ZNGA) have joined together to settle a lawsuit that alleged “The Ville” game copied “The Sims Social,” an EA game that operates on Facebook’s (NASDAQ: FB) social network. According to Kelly Kunz, a spokeswoman at Zynga and John Reseburg, a spokesman at Electronic Arts said, “EA and Zynga have resolved their respective claims and have reached settlement of their litigation in the Northern District of California.”

Renren (NYSE: RENN) is trying to respond to heightened competition and weaker demand from advertisers. It has launched two new applications for smartphone users as it contends with increasing competition across the world’s largest internet market. The new application is Bobo, which records and modifies users’ voices to make them sound like cartoon characters. Renren also lauched Meimei, a photo application that finds out human faces in images and then enhances the lighting and complexion.

Other social media stocks are disappointing investors. Yelp (NYSE: YELP) shares dropped after reporting a wider quarterly loss than analysts expected as it increased spending to spread out into new markets. Jeremy Stoppelman, the CEO of Yelp, is fixated on expanding into new geographic areas, mainly outside the U.S., in an attempt to attract more advertising dollars. In 2012, the company expanded across 26 new markets, including Poland and Turkey during the fourth quarter, while the new location would commence generating revenues in the next 18 to 36 months.

According to Tom White, an analyst at Macquarie Capital USA, the company will have to prove itself that it can earn profit from abroad also during 2013. Mr. White said, “Given this uncertainty and likely decelerating growth in its legacy local ad business, we remain on the sidelines.” Tom White also noted said that the company’s acquisition of Germany’s Qype in 2012 has increased its business in Europe and that so far the response in the UK is positive.

During the fourth quarter 2012, Yelp reported a net loss of $5.32 million or 8 cents per share. According to a Bloomberg analyst survey the projected average loss was 5 cents per share. Revenue increased by 65% to $41.2 million, while sales and marketing expenses increased by 59% to $25.5 million. The company’s EBITDA during 2013 would also be dragged by the spending on expansion into international markets.

The company’s sales for the fourth quarter were over the $40.3 million average analyst collected by Bloomberg. During 2011, the company reported a net loss of $9.05 million or 56 cents per share, on revenue of $24.9 million. The company expects to report revenue of $44 million to $44.5 million during first quarter 2013. During the first quarter of 2012, sales were $27.4 million.

Total reviews on the company’s sites, where customers rate and remark on local businesses from hair salons to insurance agencies and doctors’ offices, grew by 45% to over 36 million at 2012. The company also said average monthly unique visitors increased by 31% to about 86 million. It also carved out a niche for itself in local advertising, a major revenue source, vying for a stake in a local online advertising market that would increase to $38.1 billion in 2016 in the US, from $21.2 billion in 2011. Revenue from local advertising has enhanced from 87% in the fourth quarter to $33.9 million or 82% of total sales.

According to Stoppelman, the company’s mobile applications were used on approximately 9.2 million unique devices on average per month, and about 46% of the total traffic comes from applications on smartphones and tablets.

Threats From New Entrants

Any well-known social media companies could be blind-sided by new entrants. Relationship Science, which was established by Kenneth Langone and Henry Kravis, is launching a professional-networking service that uses Internet research to connect elite decision-makers. It would map client’s relationships with over 2 million influential people in the fields of business, finance and nonprofit organizations, assisting them to create deals that sell products and raise money. The company aims to earn an edge over LinkedIn and Facebook by not depending on social networks or user-inputted content. The service would reduce the Web for related information on business leaders and their relationships, and use that research to display how people connect.

According to Neal Goldman, the founder of Relationship Science, “As someone who has raised capital, extensively engaged in direct selling and built mutually productive partnerships throughout my career, I continuously grasped for ways to better leverage information and my relationships.”

Lofty valuations

These stocks are either unprofitable or have huge price-to-earnings multiples:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>EPS Growth Next 5 Years</span></strong></p> </td> </tr> <tr> <td> <p><span>ZNGA</span></p> </td> <td> <p><span>Zynga</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.99</span></p> </td> <td> <p><span>1.4</span></p> </td> <td> <p><span>21.0%</span></p> </td> </tr> <tr> <td> <p><span>RENN</span></p> </td> <td> <p><span>Renren</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>2.63</span></p> </td> <td> <p><span>1.08</span></p> </td> <td> <p><span>20.8%</span></p> </td> </tr> <tr> <td> <p><span>YELP</span></p> </td> <td> <p><span>Yelp</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>10.07</span></p> </td> <td> <p><span>8.38</span></p> </td> <td> <p><span>18.5%</span></p> </td> </tr> <tr> <td> <p><span>FB</span></p> </td> <td> <p><span>Facebook</span></p> </td> <td> <p><span>2893</span></p> </td> <td> <p><span>13.54</span></p> </td> <td> <p><span>5.84</span></p> </td> <td> <p><span>29.2%</span></p> </td> </tr> <tr> <td> <p><span>LNKD</span></p> </td> <td> <p><span>LinkedIn</span></p> </td> <td> <p><span>846.11</span></p> </td> <td> <p><span>17.77</span></p> </td> <td> <p><span>19.02</span></p> </td> <td> <p><span>60.1%</span></p> </td> </tr> </tbody> </table>

Price-to-sales multiples of 10 or higher are very, very hard to understand. For this reason alone I would stay away from Yelp, Facebook, and LinkedIn. Renren and Zynga might actually be cheap and are worthy of more research.

Conclusion

The only social media stocks trading at interesting price multiples are Zynga and Renren. At current price levels stay away from Yelp, Facebook, and LinkedIn. Even thought they may post excellent growth, they are nowhere near acceptable valuations.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends LinkedIn. The Motley Fool owns shares of LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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