Today, Facebook CEO Mark Zuckerberg turns 28 and gets the ultimate birthday gift: His popular social networking site is expected to go public later this week. The IPO could be valued at nearly $100 billion. Meanwhile, Yahoo, another company that also once had a bright future, continues to undergo upheaval as it struggles to define its mission.
Facebook is expected to start selling stock to the public and begin trading on the Nasdaq Stock Market on Friday. One of the things that are remarkable is how quickly Facebook became so valuable. Can a company started less than a decade ago in a college dorm really be worth that much?
To put this in perspective, when Facebook goes public it will probably be valued at more than Boeing and Ford combined. But Facebook's profits are relatively minuscule.
So to justify its sky-high stock price, Facebook will need to grow like a weed for the next few years. The amount of money it brings in will have to double and then double again for this deal to make sense for long-term investors.
Right now, more than 80 percent of the money Facebook makes comes from advertising. So that piece of its business needs to expand really quickly. But Facebook doesn't want to clutter up its site with too many ads and annoy its users.
Late last week Facebook gave us one hint about where it might be headed. The company has huge amounts of data about each of its users. It knows your likes, your friends — and where you went to school. Right now it uses those data to sell ads aimed at you, but those ads only appear on its own website.
Friday Facebook tweaked its privacy policy, allowing it to use that information to place ads aimed at its users anywhere on the Web.
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So Facebook has to walk this line, while at the same time adding members, selling ads and figuring out how to collect even more information about us.
If Facebook doesn't figure all of this out, it will be very bad news for investors.
Investors who buy Facebook this week and plan to own this stock for the long haul are betting on a kind of crazy, almost unprecedented growth. Because without that, Facebook begins to look a lot like another Silicon Valley company — Yahoo.
Right now, Yahoo and Facebook sell just about the same number of ads. They both have audience measure in the hundreds of millions. But Yahoo stock is worth one-fifth of Facebook's projected value.
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So this week as Facebook goes public, it's worth remembering that Yahoo was once valued by Wall Street at more than $100 billion too.
First a fairly technical point about marketing. Let's say you're on Facebook and you're in the market for a car and, as luck would have, I own an area dealership that sells the make of car you prefer. Though it doesn't entirely replace the need for untargeted marketing for things like brand building, being able to get my ad to you is quite valuable, but that value drops quite a bit if I find out that some other local dealership hit you with a similar ad when you went to another site. The value probably doesn't drop by half (you're still a good prospect even if I have some competition), but the expected return on the ad has dropped.Assuming rational players and reasonable efficiency, doubling the number of ads per user should increase Facebook's revenue, but by a factor of less than two.
This brings us to some more basic points. Facebook is a well established company with respectable revenue and a huge user base. If you were worried about Facebook going under, these would be wonderful attributes. If you're worried about Facebook not justifying its stock price, these are causes for concern.
In order for it to be a good deal, Facebook has to grow at a fantastic rate over the next few years. Unfortunately there is a limited pool of potential users and each of those users has a finite amount of disposable income. Of course, those are both very big numbers, but not so big that Facebook wouldn't have to command a significant share of both. That's not impossible but as a general rule, the closer those upper bounds get, the more difficult growth becomes.
And that's assuming almost complete market dominance. Facebook does have substantial first mover advantages but we're talking about a volatile segment of the economy that could be turned on its head by a major technological innovation. There's also the possibility of some other deep pocketed companies making a play for FB's marketshare (already happening with Google), or of small niche competitors getting a foothold or even a major open source alternative. Then, there are the potential regulatory issues Henn mentioned in one of the sections I didn't quote.
None of these things threaten the existence of Facebook but any one or two of them could prevent the company from justifying its price.
The comparison to Yahoo is especially interesting.Yahoo has recently become a bit of a whipping boy for the financial press, despite the fact that it's a company with some pretty good fundamentals (hundreds of millions of visitors and billions in revenue according to Wikipedia), more threatened by management hysteria than by any flaw in its business plan.
There are differences between the two companies and good reasons to value Facebook higher than Yahoo, but to get the gap we see here you have to start considering bad reasons as well, and ddulite investors are high on that list. At the height of the tech bubble a dozen years ago, Yahoo had the aura of being the next big thing in technology and its stock broke $118. Now the aura's faded, it's trading for more than a hundred dollars less and it can't get any respect.
Today that aura surrounds Facebook and people are once again failing to price in potential problems and limitations. Perhaps things will work out better this time (but I don't think that's how the smart money will bet).
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