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Social Media Stocks: All Hype, No Profit?

The Facebook IPO is coming! The Facebook IPO is coming! The Facebook IPO is coming!

After relentless speculation and anticipation, the most popular social network site finally filed for its initial public offering (IPO) yesterday.

Sadly, we’ll have to endure another couple months of “friending fever” before shares actually begin trading. (The anticipated IPO date is sometime in May.)

While we wait, no doubt investor interest in other social media stocks is going to heat up. But please don’t let the hype push my warnings of a few weeks ago into the dark, deep, unreachable recesses of your mind. (WSD‘s Justin Fritz has some choice words on the subject, as well.)

Almost without exception, social media IPOs have proven to be a sucker’s bet. To date, none of the hype has translated into any profits for everyday investors. And I don’t expect that track record to improve any time soon.

Here’s why…

Zynga: Still a Skeptic

Aside from Facebook’s IPO filing, the next biggest news in the social media space of late is that social-gaming company, Zynga (Nasdaq: ZNGA), is considering expanding into online gambling.

Some will argue the move is logical. After all, Zynga already runs the country’s most popular online poker game, Zynga Poker. So it would just be tapping into its user base to offer another product of interest.

My response: Anybody home? Huh? Think, McFly. Think!

Remember, Zynga was only founded in 2007. By all standards, it’s still an infant. And yet management is already looking for new growth opportunities?

Forget being overly reliant on Facebook. Forget operating in a hit-driven industry. Forget about deriving the overwhelming majority of its revenue (96%) from a microscopic minority of its users (3%). Changing focus so early on is the biggest red flag of all for Zynga’s stock!

I mean, think about it. Currently Zynga operates a business with first-mover advantages and limited competition. A move into online gambling, however, would carry none of those benefits.

Not to mention, it introduces and exposes the company to a world they know very little about. Namely, regulation.

In the end, Zynga’s management is sending a message to investors that growth for its core business is already waning. After only seven years. And it’s waning so much that they’re on the hunt for new growth opportunities in industries completely outside their core competencies.

Given all that, I stand by my conviction to avoid Zynga’s stock. Even in the face of “Buy” recommendations from Wall Street titans, Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), JP Morgan (NYSE: JPM) and Barclays Capital. (They were all underwriters for the Zynga IPO, by the way, so they’re probably not the most unbiased parties. Just saying.)

Groupon is Guilty, Too!

Sadly, Zynga’s actions aren’t isolated. They’re symptomatic of a much larger problem in the social media industry.

Consider daily deals juggernaut, Groupon (Nasdaq: GRPN), for instance.

Well before it went public, we panned the stock. And for good reason. It, too, is guilty of expanding outside its core competencies too soon in its life cycle.

The company went from offering a single product – daily deals for consumers in their local markets – to expanding into an ever-increasing list of products. Groupon now offers travel deals, event tickets and retail products.

Keep in mind, this is the company that literally created the online deals market in 2008. Now, just four years later, it’s looking for growth in highly competitive markets dominated by the likes of eBay (Nasdaq: EBAY), Amazon (Nasdaq: AMZN) and Travelzoo (Nasdaq: TZOO).

That’s a problem. Clearly, its early growth and original business model isn’t sustainable. And the latest results bear it out. Margins are shrinking, down from 44% of billings in the first quarter to 37% in the third quarter of 2011.

Bottom line: The fundamentals that shot social media companies to instant stardom are already fading. That doesn’t bode well for future share prices. And when the history books are written, I’m convinced the only ones who will have profited from all the hype are going to be the investment bankers, not everyday investors like you and me.

Ahead of the tape,

Louis Basenese