Facebook: where to from here?

Facebook: where to from here?

I have spoken at length about Facebook in the report and on Virtually Live since it first announced its IPO (initial public offering) and even before then, when discussing other social networking website floats. The recent falls to below $US20 (approximately half its listing price around three months ago) in the wake of its quarterly numbers have prompted me to revisit the discussion, especially with the benefit of looking at the updates of related companies such as Zynga (which actually accounts for a big source of Facebook’s revenues) and LinkedIn (the big success story in stock market performance terms in the social networking space).

On the face of it, the results weren’t all that bad. Revenues actually exceeded expectations and profitability was much improved (excluding IPO costs). Where the numbers spooked the market was that margins didn’t meet expectations, and compounding that issue is that revenue gains were at a slowing rate. Obviously, most companies can only dream of the revenue gains and customer increases that Facebook is seeing, but when you list at a market capitalisation of over $100bn (and on a multiple of around 100 times earnings), then expectations are sky high.

Facebook also reported active user numbers of 955 million, an absolutely astonishing number and the sheer size of that number shows what an incredible impact Facebook has had at a social level. But that doesn’t necessarily translate to a solid business model, and I find it interesting that now CEO Mark Zuckerberg is being questioned, when realistically Mr Zuckerberg remains a visionary, and that hasn’t changed because investors overestimated the potential profitability of his company. Silicon Valley and Wall Street don’t always match (the botched IPO makes that very clear), and in my view, it was a mistake for Facebook to list so early in its quest to monetise users. The biggest mistake Facebook can now make is to adjust the Facebook experience to maximise profits when the sheer fact that Facebook was never about profits (and therefore online advertising) is part of the reason it became so popular in the first place.

So it has been an interesting observation for me to realise that Facebook is one of the most amazing companies that has existed, but it’s a very average one in terms of potential profitability. Over the years, I have always advised members, when asking about the next ‘concept stock’, that there is a huge difference between a good idea and monetising it. Facebook is now realising this as its huge audience is waking up to the next great trend in tech – the move to mobile devices. Between tablets and smart phones, people do so much more of their computing (be it banking or social networking) on the go. And the unfortunate reality is that mobility means smaller devices, and quite simply less space to advertise on. Remember that people loved Facebook originally because it had no advertising, and remaining ‘cool’ was perhaps Mr Zuckerberg’s biggest game changing idea. Changing direction to suit the investing world might lead to shorter term profits (with invasive and annoying mobile advertising), but likely at the cost of its future, and it would be a sad outcome to look back ten years from now and call Facebook the next Yahoo or MySpace.

One last observation I would like to make is about Facebook’s contemporary in LinkedIn (the professional social networking site), which must be considered the biggest success (at least when considering potential profitability). Even though the stock isn’t too far above its listing price a little over a year ago, the company has reported very strong numbers since its listing and has proven itself to be a strong business model. But in the case of LinkedIn, it is a case of the tail wagging the dog, in that the huge numbers of users that have joined because of its wide reach (no different to Facebook) have led to the growth of the recruitment side of the business, whereby LinkedIn gets paid by employers to recruit staff. This is a very interesting difference and importantly, advertising revenues are not the main game as they are for Facebook. Unfortunately, I don’t believe Facebook will ever have the advertising appeal of Google where ads are tailored to searches. Instead, Facebook tries to target its audience’s advertising via the user’s profile (such as age and interests) and quite frankly, intrudes on people’s guilty pleasures. I have never clicked on a Facebook ad while Google has led to plenty of purchases I’ve made. Unfortunately, advertisers know this so in my view, the problem is more basic than space in which to advertise.

The rub of all that I have said is that while I continue to believe Facebook is a wonderful company and a real game-changer, I still think the future for shareholders is a bleak one and I can easily see lower prices ahead.

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