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Facebook's vicious cycle - the
price of playing by Wall Street's
rules
Last week, the
share price of the website that counts one in
seven human beings alive as a registered user took
another hit, proving a couple of things: One,
there's no business model in social media; two,
Wall Street is a bitch. By KEVIN BLOOM.
In his letter to investors before the
Google IPO in 2004, co-founder Larry Page noted
that as a private company his little search engine
had always been focused on sustainable growth, adding
that it fully intended to retain such focus
when it went public. He warned potential investors
that if opportunities arose whereby executives
needed to forfeit short-term results to secure
lasting shareholder value, those opportunities
would be taken. "In our opinion," wrote Page,
"outside pressures too often tempt companies to
sacrifice long term opportunities to meet
quarterly market expectations."
Sound
familiar? Consider the words of Facebook founder
Mark Zuckerberg, before that modest company's IPO
in May: "We don't build services to make money. We
make money to build better services… People want
to use services from companies that believe in
something beyond simply maximising profits."
On both counts, of course, while the sober
pronouncements of the respective Internet gurus
may have been a required item in the prospectus,
it was perfectly understood by all involved that
Wall Street wanted just one thing: yup,
"maximised" profits. In the former's case, these
were quick in coming. Google's first earnings
report post-IPO showed strong gains, with sales
doubling on the previous year (to just under $806
million) and net income up more than 150% (to $52
million). The share price rose 12% in a single
day's trading as a result.
We all know
what happened in the latter's case. Since its IPO
at $38 a share, Facebook has been falling
steadily, and is now trading at around $19. The
latest decline came last week, after the number of
shares available for trading increased by 60% (the
shares freed up on Friday represented 14% of the
total 1.91-billion that will eventually be
released onto the market). According to Bloomberg,
Friday's 6.3% tumble was the second-largest
post-lock-up drop among companies that have gone
public since January 2011.
Meaning that
unlike the Google founders - who, thanks to the
opportune timing of an explosion in search-ad
revenue, didn't have to eat their words -
Zuckerberg's sales pitch about the long term makes
him look like an ass. A minor reason for this is
that Facebook's first earnings report as a public
company, which came out in July, fueled concerns
over how quickly it could draw income from mobile
devices. And although second-quarter revenue grew
32% on the previous year, it was still down from
the 45% growth of the first quarter.
But
beyond these results - which aren't exactly
devastating - lies Zuckerberg's more substantial
reputational problem. As stated before on this
website, the months leading up to the IPO was when
the serious damage was done to his company.
Because that was when Morgan Stanley (as chief
underwriter), JP Morgan and Goldman Sachs (as
co-leads) and Bank of America, Merrill Lynch and
Barclays (as assistants on the deal), were doing
all they could to talk up Facebook's valuation - a
valuation that peaked at a stupendous,
recording-breaking $100-billion.
As ever,
hindsight allows us to squash complicated concepts
into tiny nutshells, and here the nutshell is as
follows: Facebook's IPO was manipulated by the
denizens of Wall Street, those grandmasters at
exploiting the growth cycles of over-hyped
companies, who saw in the social networking site
an opportunity to play their game on a
historically momentous scale.
Robert
Lenzner of Forbes magazine explained the above in
a slightly larger nutshell: "The Facebook IPO is a
cynical tale of selling cheap shares privately at
peak rates of growth - only to dump the shares on
the unsuspecting public when growth suddenly
slowed. Imagine; in the face of slower growth
Facebook and its financial advisers upped the ante
on the stock from $32 a share to $38 a share and
stuck another 800 million shares into the
offering. They should have lowered the offering
price into the low $20s and reduced the amount of
shares being sold."
They didn't, however,
and now Zuckerberg's words about people wanting to
use the services of companies that "believe in
something beyond simply maximising profits" read
as slightly untrue. Not that "people" are leaving
Facebook in droves, mind you. When the whole IPO
thing hit the media radar at the beginning of the
year, the site's user base was listed as
800-million; currently, in the midst of the share
sell-off, "just under a billion" is the cited
statistic of choice.
Still, despite the
fact that one in seven human beings on Earth is
registered on the site, analysts predict that the
share price is going to full even further. The
central problem confronting Facebook - a problem
it has confronted from inception - is that it is
impossible to safeguard the privacy of its users
while, at the same time, telling advertisers what
they want to hear. Zuckerberg has learned the hard
way that the surest route to a drop-off in
audience figures is a decision to sell (or even a
threat to sell) that audience's personal
information on to marketers.
As is also
becoming increasingly obvious, where a search on
Google has a fair chance of delivering a
corresponding advert that translates into a sale,
all the "likes" in the world aren't going to
persuade a person to go out and buy something.
Social media, as a Web-based offering, was
always meant to be intimate and informal,
something you engaged with at home and after-hours
- proof enough of this can be found in the
enduring policies of countless offline companies
to block Facebook from their servers. Is it even
conceivable that a company intent on safeguarding
productivity levels would block Google from its
servers? Larry Page and Sergey Brin, in their
pre-IPO spin about the inconsequence of Wall
Street's expectations, may have been acting just
as disingenuously as Zuckerberg, but at least they
had a product that was intrinsically commercial.
Which makes the announcement out of
Facebook on 15 August - that it's testing a
service allowing advertisers to place more
promotional messages in news feeds - seem kind of
desperate. Especially when you take note of the
caveat: under the service, according to a Facebook
spokeswoman, marketers can place ads in users'
main feeds even if those users or their friends
have not signaled that they "like" the advertiser.
It's a move that could easily backfire;
and the vicious cycle, initiated by Wall Street's
insane over-valuation, is suddenly being felt in
other areas too.
As noted by Wired
magazine: "Only now that its stock is coming back
down to Earth does Facebook seem to be thinking
about how Wall Street's valuation impacts the
company. With many employees' stock allotments now
underwater, morale has to take a beating. And it
isn't just company spirits that are suffering.
Because of its drooping share price, Facebook
won't be able to pay off a multi-billion-dollar
tax bill on employee equity by issuing more stock
in a secondary offering, as it had planned.
Meanwhile, the press, rather than focusing
attention on the company's products and features,
is fixated on Facebook's daily performance in the
market."
It isn't going to console
Zuckerberg that these events, given the nature of
the Wall Street beast, were almost inevitable.
Because his alternative was to keep Facebook
private, to either cash in or reinvest his profits
- $205-million for the first quarter of 2012,
proving that even a lame-duck product can make
money when a seventh of the planet uses it - but
what would be the point of that? DM
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