Bubble 2.0: will the new dotcom boom go bust?

Zynga, maker of the game FarmVille, is the latest online firm valued in the billions

There is something that the mysterious "people close to the matter" who spin these things would like you to know about Zynga.

Zynga is the little company that created the game FarmVille, the latest sensation on Facebook, and there were reports on Monday that its valuation had soared, with new investors trying to get in at prices that value the company at between $7bn [£4.3bn] and $9bn. That figure had raised eyebrows across Silicon Valley and Wall Street, and sparked a new round of concern that we are headed for a repeat of the dotcom bubble that suckered millions of investors just over a decade ago.

Reports regarding that sky-high valuation are not accurate, people close to the Zynga fundraising said yesterday. The real figure is not $7bn or $9bn – but closer to $10bn.

Eyebrows just went higher.

Seemingly with every passing day, the valuations being put on the current generation of internet companies rise still further, as new investors clamour for a piece of the action. Facebook and a host of other social media companies have revolutionised how we use the internet. In the late 1990s, it was the extension of dial-up and then broadband internet access into Western homes that prompted investors' excitement, and their hopes for vast profits from web businesses. Companies went from start-up to billion dollar valuations in a small number of years, as the bubble inflated.

Despite superficial similarities, the differences between that period and today are more notable, says Rory Maher, analyst at Hudson Square Research in New York.

For a start, the surge in valuations has so far been confined to a small number of privately-owned, pioneering companies that have built massive businesses, whose revenues have been doubling in size or more, each year. The frenzy has not extended to large numbers of small companies traded on the public stock exchanges, whose shares are easier to find.

"I hesitate to call it a bubble, because we are seeing this industry growing rapidly and a lot of the demand we are seeing reflects that," said Mr Maher. "These are private companies trading on [private] exchanges where there is a lot of demand with limited supply, so valuations have risen sharply. Investors badly want to get a piece of these companies, and they are willing to pay a premium to do so."

Zynga's two most-popular games, CityVille and FarmVille, have 96 million and 51 million users respectively, and the company makes easy money selling users virtual goods, such as livestock to populate their farms. Its profits were an estimated $400m last year, which would put its putative valuation within the range of normal stock market prices, but for the fact that it has a short track record.

There is even more debate over the valuations put on Facebook, Twitter and other newcomers such as Groupon, the email vouchers company. Goldman Sachs raised $500m from its clients for Facebook at a $50bn valuation last month, with the promise that the company would float on a public stock market by next year.

This week, Goldman's arch-rival JP Morgan said it would launch a $500m-$750m fund to invest in similar-stage social media companies.

There are two routes to profit for these pre-flotation investors. The first – by far the best – is that the companies will extend their growth. By figuring out new ways to attract revenue from game players, advertisers or other sources, these companies will be able to promise profits commensurate with the big valuations.

The second route does not require any of these companies to make a business breakthrough. It only requires ordinary investors, the kind who cannot get in on venture capital fundraisings or private market share sales, to get whipped up into a frenzy of excitement like it is 1999 all over again. On Wall Street, these investors are sometimes called "dumb money", and it is to them that the buyers of recent weeks hope to sell their Facebook and Zynga and Twitter shares soon.

There may not be a bubble yet, but some sophisticated investors are hoping there is going to be one.

The big four social internet companies

Facebook

$50bn: Estimated value of company

Founder Mark Zuckerberg

As Friendster and then MySpace fell by the wayside, Facebook established itself as the world's dominant social networking site, where more than half a billion users share their thoughts, photos and favourite links to the web. Its dominance gives it numerous ways to make big money, its investors believe. Facebook's early gestation period has been turned into an Oscar nominated film, The Social Network, starring Jesse Eisenberg as Zuckerberg.

Twitter

$10bn: Estimated value of company

Founder Jack Dorsey

Dorsey, with co-founders Biz Stone and Evan Williams, created a new form of communication: the tweet. Twitter's 200 million users think they are merely sharing witticisms in 140 characters. Investors believe they are creating a new way to navigate the internet.

Zynga

$10bn: Estimated value of company

Founder Mark Pincus

Named after Pincus's English bulldog, Zynga develops simple, social games that are popular on Facebook and other sites. The three-year-old company brought in revenues of $850m last year from players buying credits to use in games such as FarmVille and CityVille.

Groupon

$15bn: Estimated value of company

Founder Andrew Mason

More than 50 million people have signed up to receive "deal of the day" emails from Groupon, in which local businesses offer large discounts to attract new customers. Mason, 30, founded the company in Chicago in 2008, where its first deal was for pizzas.

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