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June 27, 2012

Facebook runs out of friends

The highly anticipated Facebook IPO has been on a downward spiral since going public in May, with the social network's valuation dropping from $100bn to $80bn in less than a month. This has raised questions over the firm's worth and longevity, writes Tineka Smith

By Tineka Smith

Mark Zuckerberg Facebook

Facebook’s recent initial public offering (IPO) on the NASDAQ exchange was the largest valuation to date for any new public company, raising $16bn in a day and causing the firm’s lead underwriters, Morgan Stanley, to value shares at $38 each.

But its stock had trouble staying above its IPO price during its 18 May debut, which forced underwriters to support the price. By the end of its first day of going public, shares were only $0.23 above the IPO price, disappointing institutional investors who were hunting for a first day ‘pop’.

The downward trend has since continued, and at the time of going to press the company’s share price was hovering around $25-$27, a 27% drop from its initial valuation, meaning the company is now worth around $75-$80bn (£51bn).

The consensus was that Facebook was overvalued, and furious investors slapped the social network and several banks with lawsuits for allegedly hiding critical information ahead of the IPO.

The plaintiffs assert that the forecasted negative information was only told to a select group of large investors rather than the entire community.

The market now also seems sceptical about Facebook’s future, with questions already being asked about how it will prove its still massive valuation, which areas Facebook should invest in next, and even whether the company itself will exist in the next five to eight years.

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Despite these distractions, the firm must now focus and find ways to prove its valuation, which was based on the assumption that it will see extremely high revenue growth over the next five years. Whether this is possible or not is another matter, as some experts already believe the company is peaking.

"Facebook will need to generate annual revenue of $30-$40bn in order to justify the IPO valuation of the business," says Victor Basta, managing director of Magister Advisors, an advisory firm that helps technology and Internet firms exit markets at the highest value. "This is a 10-fold increase over the revenues that it currently generates," he says. "The question is, ‘where from?’"

A significant area Facebook wants to make potentially lucrative gains in is mobile. More than half of the social network’s 900 million users access the site predominantly through mobile devices, making mobile advertising an undoubtedly important aspect of the company’s future.

Facebook CEO Mark Zuckerberg admitted to investors before the IPO that he felt the company was weak in mobile, although this is hardly a unique problem as none of the tech giants have yet cracked this advertising market.

The company hasn’t tried to hide these issues, and stated in its original Security Exchange Commission (SEC) filing that it remains dependant upon mobile operating systems and other networks that are out of its control, which also puts it at risk of being shut out by mobile competitors.

The company, however, has moved to establish a mobile presence by launching an app centre, and has recently acquired Instagram, Lightbox, Glancee and Karma.

"Facebook has taken a cautious approach when it comes to mobile investments and is just now getting into the game," says Justin Kistner, director of social products at market intelligence firm Webtrends. "The timing is perfect – its approach has set it up nicely because Facebook is the best positioned to offer the first browser-level mobile development platform. In fact, Facebook just announced it: it’s called the App Center."

Facebook’s app centre allows users to install apps on its mobile site. This means that developers, instead of needing to code to each mobile’s operating system, can simply develop for Facebook’s platform, which is OS agnostic.

Kistner continues: "Facebook’s investment in Instagram and Glancee further demonstrates its dedication to winning in mobile. As does its newly released news feed ads that will flow into mobile. If Facebook can achieve similar monetisation value for mobile users, then that will add massively to its revenue."

Phil Harpur, senior research manager for ICT at consultants Frost & Sullivan, agrees. He believes Facebook is well set up to successfully integrate mobile into its platform.

"Facebook’s recent Instagram acquisition is one example of how it is transforming its platform into a one-stop-shop for social media communication and collaboration," says Harpur.

"It is critical that Facebook continues with this strategy in the coming years and develops a richer communications platform, where users can not only instant message and make phone calls, but have access to functionality such as videoconferencing sessions. Current market indications are that Facebook is fairly well-placed to succeed with this strategy over the longer term."

This view is far from unanimous however, and some doubt not just whether Facebook will succeed in mobile, but whether the company will even still be alive and kicking in the next five years.

Disappearing act
It may be hard to believe that Facebook’s 900 million users could eventually abandon the site, but analyst Eric Jackson, the founder of Ironfire Capital, believes it is likely. He predicts the company will have fallen over by 2020.

"In five to eight years it is going to disappear in the way that Yahoo disappeared," Jackson said while appearing on CNBC’s Squawk on the Street. "Yahoo is still making money – it’s still profitable and still has 13,000 employees working for it. But it’s 10% of the value that it was at the height of 2000. For all intents and purposes, it’s disappeared."

Jackson has focused his research on how different generations of web companies have developed over time. The first generation consisted of giants such as Yahoo. The second generation was social web, led by the likes of Facebook, which caused the Yahoo generation to fade.

Jackson believes the third generation will consist of businesses that focus on monetising the mobile platform, an area Facebook is struggling to grasp. He says that companies of one generation are unlikely to successfully move into the next one: "As the world continues to become more competitive, those dominant in the previous generation are really going to have a hard time moving into this newer generation.

"Look at how Google has struggled moving into social… I think Facebook is going to have the same kind of challenges moving into mobile."

Even though Facebook has made moves to strengthen its mobile offerings, Jackson remains sceptical as to whether the company will ever succeed in this area: "Facebook can buy a bunch of mobile companies, but they are still a big, fat website and that’s different from a mobile app."

While Facebook is frantically working to strengthen its status in mobile, the company’s traditional advertising platform is slowly slipping away, demonstrated by the fact that the company’s first-quarter ad revenues for 2012 had declined to $872m from $943m in the previous three-month period.

Research carried out this year by the Chartered Institute of Marketing revealed that only a third of UK companies believe that Facebook is still beneficial to their growth. The social network is also increasingly losing its UK businesses to Twitter: the micro-blogging site now boasts that 71% of UK companies use it regularly, compared with just 55% for Facebook.

Even large advertisers are turning away, claiming Facebook does not know how to handle large accounts properly. This came to a head when General Motors announced it would be pulling its $10m advertising spend this year. GM told the media that the move was due to its marketing executives’ claim that Facebook had little impact with its customers.

Nate Elliot, an analyst at research firm Forrester, says Facebook needs to start taking marketing seriously and focus on obtaining resources based around marketing analytics tools, not mobile applications.

"Somehow Facebook still hasn’t stumbled upon a model that’s proven consistently successful for marketers, or that brings in the massive revenues to match the site’s massive user base," says Elliott.

Large organisations pulling their money means the site will see difficulties ahead, especially when attempting to maintain the growth and momentum vital to realising the company’s market value. Put simply, businesses and experts are questioning whether the site is the best place to spend marketing budgets.

"One global consumer goods company told us recently that Facebook was getting worse, rather than better, at helping marketers succeed," says Elliot. "Companies in industries from consumer electronics to financial services tell us they’re no longer sure Facebook is the best place to dedicate their social marketing budget – a shocking fact given the site’s dominance among users."

Despite that dominance, Facebook is increasingly facing competitive pressure from Google’s social media network, Google+, and its long history of advertising excellence.

"Facebook is currently finding it difficult to compete with Google’s more mature and more developed advertising platform," says Harpur. "To gain full industry confidence it will be critical that Facebook spends a lot of time and resources developing its advertising model further."

There are positives, however, as Harpur explains: "On the flip-side, Facebook’s immature online advertising model, combined with its massive global reach, gives it huge potential to go for very high revenue growth over the longer term and compete head-on with Google in terms of advertising revenues.

"Google, on the other hand, while still displaying solid growth in online advertising revenues, no longer has the potential for such rapid growth due to its more mature advertising platform."

One way Facebook can justify its valuation is by coaxing advertising away from other platforms.

"Advertising is fundamental currently, and Facebook will have to channel ad dollars away from other players and onto its platform to achieve this," says Harpur. "Enhanced services to companies would also be a logical step."

But Thomas Brown, head of insights at the Chartered Institute of Marketing, believes it’s too early for businesses to doubt their advertising schemes on Facebook, as social media marketing is still a new, unproven platform.

"In recent months we’ve seen big brands – GM included – casting doubt on the effectiveness of advertising on Facebook," says Brown. "It’s too early for brands to write off social media advertising because the medium is very much in its infancy. Television only succeeded as an advertising medium because big companies invested in experimentation, different investment and measurement models and iterative learning; the same needs to happen with social media marketing."

The potential is there. Facebook went from no revenue to $150m within three years, to $1bn currently. Magister Advisors’ Basta says the increase represents "a 40-fold acceleration", which, with the right model, will continue to gain speed.

He also suggests that even though Facebook has a large user base, venturing into the enterprise market may be the wisest strategic move for the company.

"A business like Yammer, which operates a private social network service for businesses, is a good model for what Facebook for companies could evolve into," says Basta.

But this wouldn’t be easy. Traditionally Facebook has focused on consumers, which does not give its shareholders and enterprise advertising accounts a sense of security. However, it may well have to make the move: the falling stock price means the company must evolve beyond its consumer roots.

"Facebook to date is a consumer-facing business, and is in effect the biggest and most successful vanity publishing project of all time," Basta continues. "It has a user base with the population of a continent – the first digital continent. The question for management is, ‘where next?’"

The general consensus appears to be that the company must focus more on businesses alongside its goals of improving its advertising and mobile platforms as these are the areas where it can potentially make the most money, but only time will tell if this is the right path.

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