Monday, May 21, 2012

Actual Value vs. Potential Value and the Facebook IPO

The biggest thing Facebook had going for it, going into its IPO, was the perception that it not only has a wealth of data that similar companies lack, it has the potential to transform that data into a phenomenal money-making machine. Its current performance does not justify a $100 billion + valuation, or even half of that amount. The hope was that enough investors would gamble on its potential to produce and sustain a valuation that is not supported by the numbers or by any known business plan held by the company.

If you wanted a sign that Facebook has no plan to generate the earnings necessary to support its proposed (or present) stock market valuation, you need look no further than its acquisition of Instagram. It makes sense for a company, seeing a threat on the horizon, to act quickly and proactively. But the amount paid, the promise to Instagram users to maintain it as a separate service, and the fact that Facebook was not able to mitigate the threat of Instagram by any means other than acquiring it, all serve to highlight its vulnerability. Not in terms of its mass of users, the extension of its platform and login system into third sites, and other such actions that do reflect commendable foresight and capability by the company's leadership. If you believed before that acquisition that Facebook's position is so dominant that it cannot be upset by a start-up, or that Facebook has clear focus on a single platform and won't end up fragmenting its platform and distributing its focus and resources on multiple properties, that acquisition should have made you reconsider.

And that's without mentioning the most obvious reason to believe Facebook lacks a plan to generate the revenues that would justify its valuation: The fact that no such plan has been implemented. I don't want to sell Facebook short (no pun intended) but I can't think of a better time for Facebook to have demonstrated its capacity to generate massive profits than over the past year. Instead it appears to be demonstrating that each additional user it acquires actually costs it money. To draw that conclusion on the available data would be premature, but it's not an impression I personally would have wanted to leave room for, going into an IPO. It reminds me of the comments I heard from an analyst, talking up Facebook's future, by suggesting that the company has enormous capacity to expand in China and India. Well, I'm sure it does, but how is that going to generate profits?

Reuters reports,
Facebook Inc's underwhelming debut on Wall Street increases the pressure on the social networking giant to deliver stellar growth - a novel situation for Chief Executive Mark Zuckerberg, who has been clear he is more interested in building products than making money.
If the lead-up to the IPO didn't pressure Facebook to deliver stellar growth, why would the present situation? Facebook is "only" worth $76.3 billion? Its key shareholders will "only" be able to spend their profits over sixteen to twenty lifetimes instead of thirty or so? Go ahead - put me under that kind of pressure. I dare you.

The second part of that statement, to me, is an echo of the hype we've been hearing ever since Facebook was worth fifteen... no, thirty... no, fifty... no, one hundred billion dollars. Zuckerberg is saying "Gamble on me, gamble on the future of this company, gamble on the idea that with phenomenal amounts of money available we'll build some jaw-dropping products." If you're buying Facebook stock with something else in mind, you simply haven't been paying attention. In a sense it's fair for the article to point out that Facebook is a profitable company and that many other multi-billion dollar companies of the current Internet bubble are gushing red ink, but that's simply a reflection of the hubris of the bubble. Facebook is "worth" $76 billion or so because of that profit - if it were gushing red ink, it might only be "worth" $40 or $50 billion to the same set of investors.

Can we at least be this honest? When, going into an IPO, a company expresses "that 'we don't build services to make money; we make money to build better services' and refer[s] to the company's 'social mission'", that company may well make the coolest stuff in the world but it has little to nothing in the pipeline that it expects to generate revenues that would justify its proposed valuation? I'm prepared to be surprised, even shocked, by an announcement that upsets my expectation and proves the genius of the speculators. But....

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