Facebook is looking to raise up to $16bn from the markets at a valuation of up to $104bn, money that will allow it to do amazing things. But the valuation it is seeking is based on it already having done those amazing things. And it simply hasn’t. Here is a researcher’s perspective on the IPO.
1. Facebook advertising must be a great revenue driver right?
No. Click-through rates on advertising are VERY low by industry standards. Source: http://www.computing.co.uk/ctg/news/2175024/facebook-advertising-failing-click-users-study
2. But all those big brands have piled in. They must know what they are doing, right?
No. Brand pages are not working well for big brands. Millions of Facebook likes do not allow individual FB users to be targeted by brands. In fact the brand’s updates soon disappear from the consumer’s newsfeed unless the consumer continues to engage. And less than 1% do. Source: http://adage.com/article/digital/sexy-brands-struggle-low-engagement-facebook/232993/
Bellwether consumer durable brand General Motors announced yesterday it was pulling its $10m advertising budget. WPP’s Martin Sorrell highlighted the “limited success” of Facebook for advertisers, noting that it hadn’t appeared to effect the IPO.
3. But Facebook is all about viral marketing, right? You don’t have to pay for media, because if the content is cool enough, people will pass it on on its own.
No. The maths doesn’t work here. Facebook messages that succeed in creating a “global cascade” in the jargon – i.e. go viral – tend to have a large number of starting points and relatively short chains (numbers of people passing the message on). In other words, something can go viral in Facebook if a lot of people hear about it from outside simultaneously (because of external advertising or news coverage). Facebook itself is not the means for this to happen. The limitation is the small size of each user’s social graph (the number of their Facebook friends). Source: http://snap.stanford.edu/class/cs224w-readings/sun09contagion.pdf
4. Hey, sourpuss, they’ve got 900m fricking users. That’s 70% of the world’s internet population. I mean – that’s got to mean something, right?
Yes, it is very big user base, but each of those users is valued at $100 or more. And at the moment, they aren’t doing that much for Facebook. In fact average revenue per user (ARPU) is falling at $1.21 per quarter, down 7% year on year. Verizon, for comparison has quarterly ARPU of $160. That’s revenue, not profit. And with such a high penetration rate it is hard to see where future user growth is going to come from. (It is worth remembering that AOL and TimeWarner once had an overwhelming domination of the internet access market. Things can change.)
5. But still Facebook has all that content produced by its users. There must be a business letting people search through all that great stuff?
Not one that Facebook can exploit. Facebook doesn’t archive or index its pages well, until recently the industry gossip mill suggested that everything was stored in cache. As a result it has had little visibility on its key asset – customer data. See: http://www.slashgear.com/facebook-data-archive-incomplete-say-privacy-hounds-12222664/
Partly in consequence the Facebook search experience has been very poor, making it hard to sell contextual ads. That’s another revenue model blocked to the company.
6. But all of those likes, that gives an advertiser really cool information about a user. That is gold dust, correctamundo?
It may be, and Facebook since 2010’s f8 conference has offered access to very valuable data, but that data requires explicit user opt-ins to be exploited. That means that it is most valuable to application builders like Zynga or Spotify. Facebook have struggled to make that data work for advertisers (see above).
7. And Facebook has really got mobile nailed, correct? I always see people using Facebook on trains.
Mobile is an increasingly important platform for Facebook, but they are scratching their heads about how to make it generate revenue, a fact they were forced to acknowledge in the run-up to the IPO. [More on this and wider challenges to Facebook’s advertising model from BTIG’s Rich Greenfield]
8. Hey smartass, look at the valuation of the business! All those clever people on Wall Street have run the numbers, they must know something.
They do: Facebook has decided to up the amount of stock it is selling in its upcoming IPO by 25%. But it is only selling a small quantity of stock 422m out of 2.7bn shares (15%) which may keep the demand high. That might provide a short-term bump to the stock, based on scarcity, but in the IPO insiders (who know the business) are selling, outsiders (who don’t) are buying. Source: http://www.ft.com/cms/s/0/80f2e7a0-9f59-11e1-a255-00144feabdc0.html#axzz1v74Q40uw
If you can get the stock tomorrow, buy it and flip it. Because long term Facebook’s quarterly numbers are going to be vulnerable to the issues above. It doesn’t have a proven revenue-generation model to justify that valuation, and without that the numbers don’t stack up.
Facebook can be a great business. It’s just that there is a barrel load of execution-risk in there.