The relatively brief history of social media is littered with the skeletons of flash-in-the-pan growth stories such as SixDegrees.com, MySpace. and Friendster that never realized their lofty potential.
Then there was Facebook (FB 0.80%). Though a spate of social-media services -- including Twitter (TWTR +0.00%), LinkedIn (LNKD +0.00%), Instagram, and Pinterest, to name a few -- soon followed in its successful footsteps, Facebook was the company that brought social media into the mainstream.
Each of these names has carved its own niche, but the risk of slowing user growth or outright user fatigue always lurks at the fringes for these social-media darlings. And although one recent report suggests that today's social-media leaders are moving toward the peak of their business life cycles in some places, that simply isn't the case for a few reasons.
Peak social?
Last week, the Pew Research Center released its Mobile Messaging and Social Media 2015 report, which contains a number of important insights for anyone thinking about investing in this constantly shifting landscape. To gather this data, Pew conducted 1,907 phone interviews with U.S. citizens 18 or older in every state and D.C. in both English and Spanish. It then filtered the data to reflect the demographic makeup the of United States. The high-level takeaway for publicly traded social-media stocks such as Facebook, LinkedIn, and Twitter is that user growth has largely slowed to a trickle, at least among adults in the United States.
This data paints an alarming picture for social-media stocks whose valuations are predicated, at least in part, on their ability to drive future user growth. The idea that the user-growth runway has already reached maturity in developed markets isn't a comforting thought. However, though such concerns are valid, these numbers highlight an important but less fatal line of discussion for these social-media darlings.
An unfortunate tail risk for social stocks
Rather than signaling a need to panic, Pew's research reconfirms what is perhaps the most significant tail risk facing any social-media business -- user fatigue. That doesn't appear to be a huge problem right now for any of the names on this list. Even as their user bases reach saturation in developed markets, each name has shifted focus to expand internationally. Instead, slowing growth implies nearing market saturation in only certain areas, which is something all businesses face and is not a signal that users have begun to migrate off these various platforms.
With hundreds of millions people using Facebook, LinkedIn, and Twitter, each of these companies enjoys network effects to varying degrees. "Network effect" refers to a platform's value to its users and how that changes as its user base expands or contracts. So in terms of Facebook, for example, the social-networking service becomes more useful for every user as more users join, since it increases the number of friends for you to keep in touch with. The same holds true on the business end of these services. Largely driven by advertising revenue, although LinkedIn is somewhat more diversified, each service's value to advertisers derives directly from the audience it enables them to access.
The problem is that from a technological standpoint, barriers to entry aren't particularly high in any of these spaces, so the threat that a new, cooler competitor will steal the thunder from any of these services remains a permanent, if remote, tail risk for investing in this space. Investors accept that risk when they purchase shares in any of these companies, and there's little they can do to change it.
However, today's social-media stalwarts appear to have a solution for this risk as well -- acquisition. Perhaps most notably, the rapid rise of Instagram, especially among millennials, provided a viable option for connecting with friends and offered what may be the first genuine alternative to Facebook. The solution? Facebook simply bought Instagram, gaining valuable talent and a budding ad platform along the way.
So while the Pew research doesn't suggest that LinkedIn, Twitter, or Facebook have reached a point of saturation, or will anytime soon, it does rekindle an important discussion of some of the bigger risks these online businesses face and that all investors in these names have to understand.
