Thursday, 8 December 2011

Will Facebook Fail?

The IPO is slated for next year. Facebook has 800m users and it's estimated valuation for that float is $100bn. Simple mathematics on the potential 'monetisation' of that huge user base means that the valuation looks cheap at just a few dollars per head. Facebook can't fail.

Or can it?

We all remember, and some have the scars still, web 1.0 and the furore that it created about valuations. Every business that cropped up had 'massive potential' and we all fell for it. Few really have survived and fewer still have delivered on that dreamy potential. In between then and now, there have been just one or two massive IPOs which have have been hyped in the same way and then delivered. Google remains that shining example of proving the case for those optimists. 

But Google had a business model that already worked. It was growing like crazy with real money flowing in through the door and had a very detailed plan of how it would not just continue to grow that model but it had several new ways to make money up its sleeve. And it has delivered on it. In fact, Google had a product or service that customers wanted, would pay for and it had several enhancements that would earn more money. Google never fell into the trap of having to think how to charge its consumers even if it had some ways to do it. It charged right from the start for services around that user base to companies that had money. Google was not a consumer business, it was a business to business.

And Google had Intellectual Property (IP). It had specific technologies and understanding of search that no others had. It still has and its still evolving. Strip away lots of other clever things, much of which we can do without if push came to shove like Google Buzz etc, Google has a prize asset that is worth $billions.

Facebook has users but no real IP. I'm sure there's lots of ways it's optimised the site but realistically it's nothing that hasn't been cloned in some way. It's value is in the potential of monetising those 800m users. So here's a 'what if?' scenario.

The top 100 users of Facebook have enormous numbers of 'Friends' or followers and some of them grow those numbers of followers in the tens of thousands per day (you can look this up, by the way, on Facebook itself). These would be the likes of superstar celebrities. These celebrities are paid nothing by Facebook yet the number of times their pages are accessed per minute far out weigh the vast majority of the 800m users have accessed in an entire year.

Facebook is nothing better than a decent sized TV channel that shows some interesting content. Just like the ratings, some content is more polar than others. So what if some of that content switched to another channel? What if Google+ said to Lady Gaga, come to my site and close down your Facebook site and I will pay 50% of every piece of revenue I earn from advertising paid for on your pages? Would she move? What could Facebook do about it?

It couldn't happen, could it? Well they probably said that about the Premier League or naming Highbury the Emirates Stadium. You see Facebook has several ways it might potentially make money but without the following of those users interested in others then it falls to pieces.

We are in what is often called the 'Follow Me' era of social networking where it is about getting your personal brands worth more by adding followers. Klout, Peer Index and others then tell us how 'influential' we are on the various options to network and it's obvious some 'brands' have better cache than others. Well, if you went to a Lady Gaga concert and you saw an advert for Coke on stage as she sang you can bet your bottom dollar that the Lady herself would earn a great deal from it as Coke tries to leverage her brand.

Facebook has that potential problem to face, in my opinion. The vast majority of the 800m users of Facebook will never pay a penny for using the platform. However, they are definitely an advertising opportunity but some users are worth more, like premium advertisement hoardings, than others. So if the high worth ones are picked off, what is left?

Facebook has contracts but has an obligation to tear down your pages if you no longer wish to use the service. So users can come and go pretty freely. While there is no substantial alternative to Facebook to attract these big stars away there is no real threat. But Google has that potential.

Will it happen? I don't know. Let's put it this way, when Sky took boxing into premium land, the sport lost a massive following. In fact, I have not actually watched a whole boxing match since whereas when it was free on TV, I was an avid fan. Monetisation has the potential to alienate people and lose followers completely.

History is a funny old thing. While social networking is new and its business models look different with multifarious opportunities to potentially make money, there is a fragility to the model that makes it creak at the edges to the point that if something gives then it could all implode.

At the end of the day, every business needs to have a sustainable engine for making money. Facebook has advertising today producing around $3bn a year and growing but if that was the main contributor to the valuation then the company, in my opinion, would be worth no more than $30bn. That's still a heck of a valuation but it does kind of show that there is a substantial amount missing from the equation. And even then, there is a threat to that business in the competitive world to attract the marketing budgets of big firms which are notoriously tough to sustain.

Even though online advertising is on the up, we all know that business has its limits and is notoriously fickle. We all know that certain places to advertise cost a great deal more than others and celebrities have a strong opinion of how they should be used in adverts. 

That day of dichotomy between the 'followed' stars and Facebook has not arrived. I predict it will arrive in some form or another at some point in the near future.

There are other potential ways to monetize us like having the Facebook 'wallet' or virtual credit card system - but that would rely on us waiving our rights to privacy and giving our credit card or bank account details to a site already famed for its accessibility. I can't see those easily making up the difference. 

Facebook looks a fantastic opportunity, have no doubts about it, but money making is all about the execution on a sustainable business model and it's not there yet. It's a 'potential potential' business still and I think for that reason it's over-valued by a large distance, possibly tenfold. And what it has is not bullet proof, either. 

Three things can happen in the coming years beyond an IPO - 1) Facebook makes more money than everyone expects, 2) Facebook makes the money everyone expects and 3) Facebook fails to live up to expectations. If you weigh those options up in the cold light of day, the best you'll get is a 33.33% risk of any of them happening - and that's not good odds in my book.

Buyer beware at this price.

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