Facebook: IPO postmortem – a dispassionate analysis

This post is a collection of thoughts that I’ve had about a post-IPO Facebook, I realise that there may not be a cohesiveness to some of this but I wanted to put it all down in one place. In less than two months, Facebook has gone from being the technology sector darling to its typhoid Mary; what does this all mean?

One thing as a reader that you may want to bear in mind is that I have been pointing out flaws in the Facebook model since 2008 on this blog, I stand by the content that I put in those earlier posts.

I have broken this post down into five parts:

  • Factors that maybe influencing the Facebook cynicism
  • How much is Facebook actually worth
  • What are you actually buying with Facebook?
  • How might the Facebook IPO debacle adversely affect Facebook beyond the class action law suit and likely SEC investigation?
  • Facebook and those that have gone before

Factors that maybe influencing the Facebook cynicism

  • Silicon Valley is biased toward the new new thing; since that is where they make their money: the start-up that gets bought or (less likely now) the small public company that grows into a leviathan a la Apple. By comparison Facebook is already a leviathan and the fortunes have been already made
  • There is at least some unease that Facebook represents a turning point for Silicon Valley and not in a good way. It is much easier for VCs to fund ‘easy’ innovation like Facebook rather than ‘hard’ innovation in semiconductor designs and processes or biotechnology. There are also structural aspects to this: the US is no longer the pre-eminent market for new product or service categories, other countries like China and India have the intellectual firepower and capital to do it at home now. Just look at Jack Ma of Alibaba, Robin Li of Baidu and Pony Ma of Tencent. China is designing some of the world’s most powerful supercomputers running on its own chip designs and with both Huawei and ZTE the world’s leading creators of telecoms equipment
  • When you are worth in the region of $100 billion dollars as a company it hard to grow at a respectable percentage, so sustaining a value of 100x earnings is really hard to do as this implies an astronomical continued growth trajectory
  • A subsidiary point to the market capitalisation growth prospects above is that Facebook hit the market with a valuation of 100 times earnings – which implies a massive growth trajectory and in turn a massive leap of faith by shareholders
  • Marketers public disenfranchisement with Facebook as an advertising platform. General Motors announcement that they would not be using Facebook advertising anymore two days before the IPO was a lightning rod for that sentiment. I think that the timing of the announcement indicated a desire to put the knife into Facebook, which gave an idea of how alienated GM felt as a Facebook client
  • Instagram seemed like a rather expensive folly to many at a share only deal worth $1 billion. However paying in shares isn’t like paying in cash and it took a fierce potential competitor off the table
  • The structure of Facebook’s voting arrangements emasculates shareholders, Mark Zuckerberg held some 57% of voting rights post-IPO which makes the stock unattractive to more active institutional investors. For instance, shareholders have a limited ability to push for dividends
  • Facebook managed to alienate rather than inspire trust in institutional investors by doing things differently. Mark Zuckerberg didn’t turn up to the pre-IPO roadshow but instead focused on running Facebook. This was also partly because Facebook didn’t need the capital injection, it was forced to do public reporting because of its number of shareholders, so it may as well go public
  • Facebook priced the IPO to maximise the amount of capital that the company got from the markets and didn’t price in an expensive PR ‘pop’ to the first day share price, so investors didn’t get to enjoy ‘free money’

How much is Facebook actually worth?

Which is the billion-dollar question – whilst I couldn’t put some definitive value  on it there are some pointers that we can use to steer our thinking. Let’s notionally say that Facebook has already reached its first billion users, we know that the next billion will be worth substantially less than the first billion.Frédéric Filloux pointed out in The Guardian the following advertising  ARPU (average revenue per user) numbers:
$4.34 overall
$9.51 North America
$4.86 Europe
$1.79 Asia
$1.42 rest of the world

Looking at those numbers, one could confidently say, if the numbers stayed the same, the overall ARPU would decline as growth is likely to occur in Asia and the rest of the world. It also tells us that there are a number of markets that Facebook isn’t currently seeing the full potential from. Once could imagine that Europe’s ARPU number could grow significantly, and a similar effect in the more developed markets of Asia: Korea, Japan, Hong Kong, Singapore.

Facebook could look at improving the efficiency and effectiveness of advertising platform by looking at new formats and finding ways to more effectively use data gathered from the likes of Facebook Connect and mobile applications. The company could also try and grow non-advertising parts of the business from its present 15% or so. Gaming is a huge online social activity for many people in Asia so  there is maybe more scope to grow.

I don’t think that China will be the next billion users, primarily because you have highly innovative competitors in the market already and Facebook has shown an unwillingness to bend to cultural norms such as forcing real world identity on Japanese web users. Secondly, an involvement in China would pose issues with US politicians who would use the opportunity to take a further look at the company. Whilst Facebook has stocked up on lobbyists at a commendably early opportunity compared to other technology peers it would still be unwelcome attention.

But on the face of it, none of this adds up to more than low multiples on current revenue streams, Facebook needs to reinvent other markets beyond online advertising whilst leveraging the advantage of its current user base.

What are you actually buying with Facebook?

So having looked at the current value of Facebook at the time of its IPO, the rationale for 100 times earnings didn’t seem immediately apparent. Don’t get me wrong Facebook has a lot of accomplishments that make it a very valuable company, just not 100 times earnings kind of valuable.

To realise that value you would need to transform several markets, so does Facebook have the kind of qualities that would allow it to do so?

  • A founder CEO with enough power to carve their own path – check
  • A CEO with vision – I am less sure about this one, I would argue that Zuckerberg’s skill is in a sense of timing rather than a sense of vision. He certainly doesn’t have the design sensibility or consumer zeitgeist meter than Steve Jobs did
  • Being small enough to do rapid change. This is something that Larry Page has struggled to enforce at Google and Facebook is likely to have a better chance since it is a smaller organisation at the moment
  • A strong sense of purpose? Beyond the social graph probably not

So the real question is ‘Do you feel lucky, well do you punk?

How might the Facebook IPO debacle adversely affect Facebook beyond the class-action law suit and likely SEC investigation?

I suspect that the main negative impacts if they were to occur would be in sales and engineering. Firstly sales, the teams would have to earn their money dealing with the FUD (fear, uncertainty and doubt) that the IPO threw up around the efficiency and effectiveness of their current products. Now that the quiet period is over, the company can go public on the premium inventory it has and start to answer concerns directly in the media as well as verbal briefings via account managers. The impact won’t be too severe if Facebook can change the game (like it has done by moving to a CPM measure for new formats) successfully or arrest the decline in click-through rates.

In common with other technology companies Facebook depends on being able to get the best engineering and sales talent to work for them and stay with them. This is usually done through the use of share options and giving shares themselves to engineers. The attractiveness of these offers depends on the share price continuing to rise. Now with engineers it often isn’t just about the money, but also about the kind of challenge that engineers can embrace, a good example of this would be some of Spencer Tipping’s reasons for leaving Google. But whichever way look at it money is important.

Share options buy homes, pay off college loans and pay for important life events like weddings. Shares are important for future talent acquisition and existing talent retention, so this is where there maybe more of an impact, depending on if there was a continued decline, what the vested share price for the employee, how many options they have and what their lock-in period is.

Facebook and those that have gone before

Much of the analysis has compared Facebook to Google or Amazon but I think that the comparisons are inaccurate and misleading for a number of reasons. Facebook compared to:

  • Google – Facebook has reached a Google-level of ubiquity in many markets, however I think that is where the similarities end. Facebook unlike Google doesn’t currently have a ‘killer’ advertising format, and Google had a much more unbounded growth trajectory ahead of it when it went public in 2004. If we think about Facebook’s core business versus Google’s core search business, the cost of servicing each account and customer costs much more with Facebook which will also affect profits
  • Amazon – The links between Facebook and Amazon are tenuous: both enjoy founder CEOs like Google, all three don’t march to the beat of the active shareholder drum and all of the companies have an extensive web infrastructure that they try to leverage to gain consumer advantage. Amazon has managed to expand much further in terms of organisation scope than Facebook is likely to have to grow. Amazon is selective about the geographic markets it enters so it can keep driving its average revenue per customer
  • Yahoo! – Facebook’s advertising model is similar to Yahoo!’s display model, the main difference is that the portal pays for the vast majority of its content, Facebook gets its content for free. Yahoo! has a fractured structure; particularly in Asia where Softbank and Alibaba essentially run franchise operations which means that the company doesn’t get as much economies of scale and its product offering varies enormously territory by territory. Many of Yahoo!’s early adopter customers in the UK for instance use US services (guilty as charged Your Honour) and half the UK’s traffic used to come from India. So Yahoo! has challenges in terms of advertising efficiency and effectiveness

I personally think that if you buy into Facebook’s future promise, Facebook looks more like Xerox. In the 1950s, the Northeastern US was the Silicon Valley of its day; with engineering and chemical factories around New Jersey and the Boston corridor through to New York being the home of the infant computer industry. Xerox was founded as a photographic supplies company that made equipment to develop photographic film, it eventually incubated its killer product –  xerography  which begat photocopiers and fax machines after a decades worth of work. Later on in the development period, the company invested in an insurance company to provide cash flow for future model developments. If you believe that Facebook has a bright future ahead of it, then by implication, it’s current and immediate future products like premium ads in the news feed look more like cash generative businesses to fund ‘project X’ whatever that turns out to be.

More information
The Facebook | Instagram post – renaissance chambara
Facebook: the collective hallucination | guardian.co.uk
why I left google – Spencer Tipping
Zynga IPO and thoughts – renaissance chambara
The Facebook IPO post – renaissance chambara
US shares skid as Facebook IPO stumbles
Facebook debut disappoints
Facebook Breaks Another Record: Volume – WSJ
Facebook IPO Post-Mortem – The Atlantic
Facebook’s Debut Marred by Trading Flaws – NYTimes.com
Ed Cotton: Facebook’s Dangerous Game @PSFK
Facebook’s Real Problem in Just 44 Words
Zynga Shares Jump On Facebook IPO Connection | TIME.com
What Facebook isn’t telling you about its risky ad business | VentureBeat
Analysis: A sobering look at Facebook | Reuters
Here’s The Real Problem For Facebook’s Stock Valuation
Is Facebook peaking in the US? – FT.com
Why Facebook is a dead man walking
Why Facebook is a dead man walking part II?
Why Facebook is a dead man walking part 2.5?
Risk Reduction Strategies on Facebook – danah boyd
Teens Find Innovative Ways to Control Their Facebook Presence – All Facebook
On Facebook deactivations – Jillian C. York
Is Facebook peaking in the US? – FT.com
Facebook (Kinda) Disputes Slowdown Estimates, But Declines to Give Actual Stats – AllThingsD
Facebook Is Losing Users In The Countries Where It Took Off First
If growth in the US is flatlining then where is Facebook’s growth going to come from? « excapite
Report: Facebook Grew Only 1.7 Percent in May, Dragged Down By Losses in Oldest Markets – AllThingsD
Has Facebook Peaked? | WebProNews
Thoughts on Facebook’s apparent decline in the developed world
Facebook, privacy and consumer behaviour
Facebook fatigue