Saturday, September 01, 2012
Facebook the business was dwarfed by Facebook the story. John Hearne says it was the money that bewitched everyone, it was the numbers that powered the hubris
EVERY year, thousands of companies are quoted on the stock market for the first time. The vast majority of these IPOs must content themselves with a mention in the business pages. Few make it to the front page. Facebook was different, and it wasn’t just because the IPO was so big. Facebook the business was dwarfed by Facebook the story.
There was the fact that it all began in a college dorm room, a mere eight years previously. Now, suddenly, it was on the cusp of becoming a $100 billion proposition. There was the iconoclastic 28-year-old in jeans and runners at the helm, the world leaders queuing up for a photo op, the newspaper hagiographies. The Social Network, Hollywood’s take on the company, grossed nearly a billion dollars two years before the company itself went public.
In Time magazine’s list of the most influential people of all time, Mark Zuckerberg’s name appeared between Moses and Lao Tzu.
The Moses comparison is apt, because he never saw himself as a mere businessman. He is leading the world towards his vision of a connected world. In the IPO prospectus, Zuckerberg (below) wrote that he didn’t view Facebook as a business, but as a means of social transformation.
“It was built to accomplish a social mission,” he wrote, “to make the world more open and connected.” Making money was a by-product.
But it was the money that bewitched everyone, it was the numbers that powered the hubris. Close to a billion active users — a seventh of the planet’s human population. Zuckerberg himself, holding 55% of the shares, would amass a paper fortune of €20bn, becoming one of the world’s richest men overnight. At $100bn, this would be the biggest tech IPO in history, and third biggest ever behind General Motors and Visa.
It was such a great story, carrying in its wake a string of delightful little human interest stories.
The IPO would create 1,000 new millionaires overnight, most of them Facebook insiders who had been with the company since the early days. These tech geeks wouldn’t celebrate their new found riches with Moet but with Red Bull.
They would dress in matching ‘Hackathon’ T-shirts and participate in an all-night code-writing party.
In 2005, graffiti artist David Choe was commissioned to paint a series of erotic murals on the walls of the company’s first HQ in Palo Alto, California. Facebook’s president at the time, Sean Parker, offered him shares instead of cash. In one of the most prescient business decisions of all time, Choe took him up on it. The New York Times reported that the decision transformed the few thousand bucks he stood to make into $200m.
Reading back over the tremulous newspaper stories in the weeks leading up to the IPO, it’s easy to shake your head at the runaway naivety of it all.
IPOs we were told, generally see a 22% rise in share price on the opening day. Fox News raved: “Everyone from college students to their grandmothers will be scraping together their savings to buy a piece of the biggest tech IPO in US history.”
Yet the seeds of the coming fall were also evident in the coverage. On the morning of the IPO, Time said: “Today is the culmination of eight years of hard work for the 28-year-old. It’s his big day. He deserves it.”
Yet it also pointed out that Google’s IPO back in 2004 — the previous most hyped — valued the company at a fifth of Facebook’s $100bn. Even that figure — $100 billion — doesn’t it look a little rounded up?
“Fundamental factors are hard-pressed to justify that price at present.” Time went on. “So Facebook investors are betting on steep revenue and earnings growth over the next few years. With $1bn in profit last year, the company has an extremely high price-to-earnings ratio of 100-to-1, higher than Google’s when the search titan went public in 2004.
“And by the time it went public, Google had already built AdWords, the search ad feature that continues to drive its massive profits. Facebook’s ad business is much less developed.”
From the moment Mark Zuckerberg rang the opening bell at the Nasdaq on the morning of May 18, everything began to fall apart.
Within five days, Bloomberg raged that the 13% decline in share price made the Facebook IPO the worst large-scale offering in history.
In the weeks that followed, both Facebook and its lead underwriter, investment bank Morgan Stanley, faced a storm of criticism for mishandling the offering.
It was pointed out that just a week out from May 18, the number of shares up for grabs was increased by 25%, while the asking price was also nudged higher. There was also rancorous fallout from the fact that Nasdaq’s software for IPO auctions malfunctioned on the day, causing substantial confusion among brokerages frantically working through huge numbers of client orders.
On Jun 2, the New York Times’ public editor, Arthur Brisbane, turned his fire on his own paper for being seduced by the power of the Facebook story.
He said that instead of reporting on possible double digit gains on the day of the IPO, the paper had a responsibility to warn of inflated expectations, “especially for the general reader who relies on The Times to explain the risks of the stock market.”
Three months on, the share languishes at roughly half its May 18 opening price.
After hubris, nemesis. Moses and Lao Tzu exit stage left, to be replaced by more worldly exemplars. Facebook is now being spoken of in the same sentence as casualties of the great dot com implosion of 2002. We get comparisons with AOL — a company once synonymous with the internet, now a fossilised reminder of how far it’s possible to fall.
The scales fall from everyone’s eyes. To state that the IPO price was too high is now as obvious as it was contrarian a few months ago.
Investors now suggest that while Zuckerberg may be a visionary, he just can’t manage Wall Street. And here lies the crux of the problem; a classic pull of head and heart, with Silicon Valley in the latter role and Wall Street in the former.
While Facebook’s youthful hackers, their pockets full of cash, are appealing for calm, the suits of Wall Street are apoplectic on the sidelines. What are these bozos doing with our money? The answer is that the company has been busy. Facebook has made four acquisitions since the IPO, including the face recognition platform face.com, for $100m in June. Late last month, the US Federal Trade Commission cleared Facebook’s $1bn acquisition of mobile photo company Instagram, the biggest in its history.
Trouble is, not everyone is putting their money where their mouth is. Facebook insiders made $10bn on the night of May 17. All but $1bn was liquidated over the following days. Then, earlier this month company co-founder, the world’s youngest billionaire, Dustin Moskovitz sold 450,000 shares. This, it turns out, is less than 1% of his total holding, netting him a mere $7.5m after taxes in pocket change.
More troubling, however, was the disclosure that board member Peter Thiel cashed in the bulk of his holdings — some 20m shares — at the same time, raising $400m in one fell swoop. The move drew blanket coverage in the financial press, much of it hostile. Eric Jackson in Forbes pulled no punches: “Why Peter Thiel should be ashamed, and resign from Facebook immediately.”
The problem facing the social networker is simple. Yes, Facebook is second only to Google as the most visited site on the net. Yes, it has nearly a billion active users. Prior to the IPO, investors became drunk on all that potential, that ‘reach’ as marketers term it. But you can live your life on Facebook without handing over a single cent.
So far, Facebook has been unable to find a way to turn all that marketing muscle into cold, hard cash, or at least not enough to justify the $100bn price tag.
Those who were around in the early days of the internet might remember Netscape Navigator. It was a pioneering internet browser, presenting web pages in a consistent manner across platforms. At the peak of its popularity it had over 90% market share. But you had to pay for it. When Microsoft realised the popularity and potential of the internet software market, it began developing Microsoft Explorer, and packaging it for free with its operating system. Though at the beginning Netscape had a superior product, Microsoft’s depth of pocket meant it could distribute the software without charge, even in the face of a massive antitrust lawsuit which Microsoft eventually lost. The victory came too late for Netscape, however. By 2002, it had more or less disappeared. Facebook critics now point out that the social networker’s problems bear a substantial resemblance to those of Netscape at the dawn of the last decade.
Yes, this is a wonderful product, but no, we won’t pay for it. (Which isn’t to say that Facebook in its struggle to build earnings hasn’t toyed with charging. The company recently rolled out a facility in New Zealand allowing users to purchase increased visibility for their status updates.) But nobody is betting on the company introducing charges for its core activities. The future of Facebook is advertising.
This widely accepted truism only drives a wedge further between the company’s Silicon Valley heart and Wall Street head. Facebook as a movement must preserve the user experience and resist a crude bombardment with ads.
Facebook as business must turn those precious gigabytes of user information into finely targeted, well, ads. It’s a schizophrenia for which the company has yet to find a cure.
Some commentators suggest that it’s more simple than that. Facebook is the Peter Pan of the tech world. If it is to deliver on its potential, then it must grow up.
Rob Enderle of the Enderle Group is one of leading tech commentators in the world. He too draws parallels between Facebook’s current malaise and the dot com bubble, pointing out that the fundamental problem besetting many of the casualties of 2002 is that they simply lacked the skills necessary to run those companies.
“I think it comes down to lacking core skills in critical areas necessary for the success of the service,” he says. “If the service to users is about helping them network then a set of skills surrounding behaviour, particularly with regard to communications, would be required. If revenue is tied to advertising then there should be some demonstrable expertise in advertising in the executive staff. Neither is really evident.”
Put simply, the company doesn’t understand people, therefore it doesn’t understand advertising, and for a company whose revenue stream is ads, this is not good. Enderle has put Facebook on suicide watch, and believes that without a transformation its skill sets it will quietly but certainly implode.
Critics frequently point to General Motors’ $10m desertion of Facebook on the eve of its IPO. The motor giant declared that Facebook ads simply didn’t pay off.
At the same time, a global survey carried out by digital marketing agency Greenlight reported that 44% of respondents said they would never click on a sponsored Facebook link.
WHAT everyone who bought at the IPO is betting on is that Facebook will somehow reinvent advertising. All the raw materials appear to be there. That astonishing audience: 955 million monthly users, more than half of which return every day. The company retains vast reserves of information on each user. The question which circulates endlessly through the debate is ‘how’? How is all this potential to be turned into money? The solution may be closer than we think. On CNET last week, journalist Paul Sloan dug out an interview with Facebook board member Marc Andreessen, conducted by US talk show host Charlie Rose three years ago. In the interview, Andreessen pointed out what we all know. Facebook doesn’t do the kind of normal brand advertising that we see plastered across every other site; the strategy hangs on finding another way. And if that doesn’t work? “The fallback position is to just take normal advertising.” Said Andreessen, who is still a board member. “And if Facebook just turned on the spigot for normal advertising today, it’d be doing over a billion dollars in revenue. So it’s much more a matter of long-term strategy.”
If it’s that simple, the simple turning on of a spigot — that’s a tap to you and me — it remains to be seen how long the heart can hold out before the head demands that someone start turning that tap.
Interestingly, the social networker appears to be toying with such a move. Large banner ads, of a kind once eschewed by Facebook, have been screen tested — particularly on log-out.
But this is dangerous territory.
It would be folly to believe that the product is so strong, that Facebook has become so fundamental to its users’ lives that it could never be replaced. Look what Facebook did to Myspace, and note too that despite the dominance of the Zuckerberg model, there are social network alternatives, such as Google+.
As more than one critic has pointed out, the Netscape analogy continues here. Suppose the search giant were to play Microsoft’s role, and use its vast revenue streams to keep its Google+ ads to a minimum, thereby preserving a user experience that an overexposed Facebook might have lost? Then there’s mobile.
Facebook reported that in June, 543m users — well over half — accessed their accounts on mobile devices, a staggering 67% increase since the previous year.
On the one hand, this is great; Facebook is reaching the mobile generation. But if users are intolerant of ads on computer, that goes doubly so for small screen formats.
The company is of course targeting this market very aggressively. That Instagram acquisition is all about mobile. Their application allows users to add effects to pictures taken on their smartphones. In July alone, Instagram had 80m users. Though the $1bn purchase price shocked commentators — the company doesn’t have any revenue to speak of — one thing the acquisition ensures is that the company doesn’t fall into the hands of either Google or Twitter.
In its most recent regulatory filing, Facebook said that it plans to use Instagram’s products as independent mobile applications “to enhance our photo product offerings and to enable users to increase their levels of mobile engagement and photo sharing”.
One of the other marketing tools in this space, and one on which many hopes are pinned, is ‘Sponsored Stories’, an initiative which the company began rolling out in March.
Advertisers repackage posts which then appear in the newsfeeds of the company’s fans and their friends. Zuckerberg announced recently that Sponsored Stories was bringing in about $1m a day in revenue, while an independent study pronounced them more effective than desktop ads.
The company has also launched Facebook Exchange, a platform for advertisers which works something like this: Someone visits a third party site and picks up a cookie, which is a small file which contains information on the user’s browsing activity while on that site. When the user returns to Facebook, advertisers can target him with specific information relating to what he’s just been doing on the other site.
The logic runs that for such highly targeted, real time advertising companies may well cough up more than for the unsophisticated, in-your-face banner ad.
As we in Ireland await Facebook’s reinvention of advertising, we are not of course disinterested spectators. Ireland Inc has invested heavily in social media as business proposition. Twitter and Linkedin both have a substantial presence here while Facebook employs 400 people at its Dublin HQ. If investor enthusiasm for social media cools any further, confidence in the sector will evaporate, and with it any chance of further investment and expansion. Meanwhile, the selling pressure continues. Many Facebook early investors and employees acquired shares under an agreement which prevents them from selling those shares for a limited period of time.
These so-called lock-ups are set to expire in the coming months. Some 249m shares become available for sale on Oct 15. A further 1.32bn will be released on November 14 while 49m more emerge from lock-up on Dec 14. If the owners of these shares need the cash, or if their faith is wavering, there’s every chance another wave of selling will drive the share price lower again.
Not everyone has lost their faith of course.
Supporters point out that an overvalued IPO does not automatically invalidate your business model. Yes, expectations were inflated, yes a lot of investors have been burned, but the social network’s plunge into the shark-invested waters of high finance may well provide the wake-up call that it needs.
And it’s not as if there’s no revenue there at all. The company earned $3.7bn in ad revenue last year.
While General Motors may have pulled $10m in ad spending, it’s worth pointing out that the conglomerate has an annual advertising budget of $1.8bn in the US alone.
In June, with the share price at $26, Roger Kay of Endpoint Technologies said he believed it would continue to fall in the short term, but suggested it would find the $20 level “bouncy”. So far, the price has failed to break substantially below that.
“The issues are still the same.” He says. “Shift to mobile, ad revenue not so easy with mobile, a bit of fatigue with social networking in general and Facebook in particular. Still, Facebook is a kingmaker. I believe Facebook will ultimately be able to monetise its enormous traffic, but the potential was way overblown at the time of the IPO.”
People need to focus, he suggests, on the “underlying goodness”.
In the meantime, Zuckerberg is showing no signs of concern at the plummeting share price. Earlier this week he was photographed with Frank Gehry, poring over a scale model of the company’s proposed new campus as designed by the legendary architect.
It includes a 10-acre room, covered in trees and designated as a “paradise workspace” for 2,800 engineers.
All it lacks is a Red Sea for Zuck to part.
FACEBOOK THROUGH THE YEARS
Oct, 2003:Harvard University grad student Mark Zuckerberg releases Facemash, the earliest precursor of Facebook
Jan, 2004:Zuckerberg registers domain thefacebook.com
Feb, 2004:Zuckerberg launches Facebook
Apr, 2004:Zuckerberg forms a partnership Thefacebook.com LLC with Dustin Moskovitz and Eduardo Saverin
June, 2004:The company receives its first major investment. $500,000 from Peter Thiel
June, 2004:Facebook incorporates, with Sean Parker, formerly of Napster, as president
Dec, 2004:The company registers its one millionth user
May, 2005:Accel Partners invests €13 million in Facebook
Sept, 2006:Yahoo enters discussions for a possible takeover of Facebook for $1 billion
Sept, 2006: Facebook opens it services to everyone with an email address who is over 13 years of age
Oct, 2008:International HQ established in Dublin
Oct, 2010:The Social Network opens in cinemas to critical acclaim and commercial success. but Zuckerberg describes it as ‘inaccurate’
Jan, 2011:A further $500 million is invested in the company for 1% stake, setting its value at $50 billion
Dec, 2011:New interface, Facebook Timeline is launched
Apr, 2012:Facebook acquires Instagram for $1 billion
May, 2012:Facebook’s much hyped initial public offering at $38 a share, valuing the company at $100 billion. Markets close on the first day’s trading at $38.23. Thereafter, the price plummets.
Aug, 2012:Share price falls below $20