Is Facebook like the kings clothes?

For anyone not understanding the kings clothes reference it comes from a children’s story about a king riding naked on his horse; but all of his subjects were told he was wearing some special clothes hence they applauded his outfit even though they could see he was naked as the day he was born.

I hate offering up a view that is counter to popular belief but I have been trying to understand the metrics behind the Facebook IPO. So I’ll lead with my chin and for discussion provide some evidence of my query.

The IPO offer price was $38 on 18th May (and rose to $42.05) creating a value of $104 billion making Facebook the largest tech IPO ever and the 3rd biggest ever in history. At close of business on 21st May the stock had dipped to $34.03, a drop of 11%. This makes the market cap $92.56 billion, almost $10billion wiped off the IPO valuation. That’s a lot of wonga over five days including a weekend. There exists a lot of rancour surrounding the IPO pricing for a variety of reasons. One US commentator called social network sites shares as ‘muppet bait’. Nice.

GM didn’t help by pulling all of its advertising off Facebook last week, around $10m. The GM marketing head also pulled out of the Superbowl talking about relevance in terms of selling autos.

Turning to the latest BrandZ report out around the same time as the Facebook IPO its interesting to think through the nature of the most valuable global brands and why they are where they are. In the FT pull out section on BrandZ (22nd May) the editorial talks about “Companies that have invested in developing strong brands during the downturn have retained their value better and remain popular with consumers, despite hard times.”

That phrase got me thinking – companies that have invested in developing strong brands – and I looked through the top 20 brands according to the latest BrandZ. All of the top 20 do invest in their brands in a way we would understand, i.e. they have marketing activity on a large scale with some very notable examples such as Apple, Coca-Cola, Vodafone et al. They promote their products with very strong branded activity. Facebook doesn’t.

Market capitalisation of all companies is based on present and future earnings and Facebook can’t justify its IPO pricing on present earnings, it’s all about potential. That potential is a function of global reach combined with the potential for advertising revenue. However critics suggest the Facebook platform is not rich enough for the quality of content most advertisers demand which in turn will depress advertising revenues. They may be able to fix that but at the moment it is a barrier to get the earnings in line with market cap. Also the Facebook site wasn’t designed to work on smartphones so advertising doesn’t work on mobiles; 50% of Facebook users access the site via their mobiles. Ooops.

Returning to the point about marketing investment I’m not aware of Facebook promoting its brand outside its own world. Given Facebook is a media channel in the making I would have thought it would begin to promote itself via other channels like most media owners tend to do. Facebook relies on PR which is generally very good and word of mouth via their site. A good question for investors would be ‘what if the PR goes in the opposite direction?’ for whatever reason. Rosamund Urwin in the Evening Standard said “Facebook is only a major privacy scandal away from a mass desertion”. By comparison Apple is #1 according to BrandZ and they have great products, fantastic stores and great advertising, all solid foundations for a strong brand.  Their design ethos percolates throughout their total operations.

I completely understand the phenomena Facebook has become and I also completely get the global penetration which could be a money generating machine par excellence. However in the IPO document there was only a fleeting reference to advertising so I wonder if it is simply not really on the agenda. Following the IPO launch all the staff went back to work and there was one story about an all-nighter fuelled by pizza and beer brainstorming techy ideas. I haven’t once read any reference to plans that might be focused on the wonga.

Facebook has around 900 million users, which is around 12-13% of the world’s population, i.e. 1 in 8! However Facebook revealed that its revenue per user annually was $4.34, roughly $4 billion. Google is worth twice as much as Facebook but with revenues six times greater than Facebook. Call me stupid but I simply don’t get the maths and how these valuations can be so wildly apart. Same sector, same channel, same technology. Also in the BrandZ latest publication Google’s brand value is $108 billion, Facebook’s $33 billion which is a closer relationship.

In Apples history Steve Jobs lost his job (haha) to be replaced by the chap Scully from Pepsi who ultimately made a right balls-up of the company; Steve Jobs returned around 1996′ish. The similarity might be that the creator of Facebook, Mark Zuckerberg, might also fall foul of the stock market when people start to get frustrated with the geeky playground outside San Francisco and force in a top suit from Wall Street.

I would guess the challenge for Mr. Zuckerberg now (apart from what to do with $billions) is how to stay in it for the long term and intelligently navigate the business in to a mature global player with strong revenues and returns for investors and for it not to be the kings clothes.

Quite a few do so and are long distance runners – Sorrell, Branson, Sugar, Gates, Jobs, Saatchi et al. Maybe Mr Zuckerberg will grow in to a global leader as a regular at Davos.

I can already hear the cries of ‘dinosaur’ however I’m purely raising some possible questions!


5 Responses to Is Facebook like the kings clothes?

  1. Patrick Morrison says:

    I concur: snake oil would also apply

  2. Nick Simons says:

    It’s been fascinating to watch the FB IPO hullaballoo at close quarters here in New York. The widely reported Wall Street incredulity-slash-anger at Zuckerberg’s “disrespectful” choice of wardrobe alone has provided a lot to chuckle about. Good grief.

    Sorrell’s view on the price was that the company’s worth what people are prepared to pay for it. Fair enough. Then again Richard Holway of TechMarketView reckons, “based on their research”, it’s vastly overpriced and values the company at a mere $50billion. What said research entailed wasn’t mentioned in the article I read but presumably there are some facts lurking behind that assertion somewhere.

    But who knows who’s right?

    What we do know is there are some eye watering FB facts: with over 900 million active users it is arguably the third largest population on the planet, behind only China and India, way ahead of the USA and c. 200 million more people than the entire population of Europe. On average they have 300 million photos uploaded every day. That’s roughly 5 pics for every man, woman and child in the UK. Every day. Mind boggling. Nearly 400 million people use the site 6 days out of 7 every week – significantly more people than in the whole of the USA. Their latest numbers show revenues of c. $3billion with profits of $1billion. So, not all bad for a 7 year old company.

    That said and impressive facts aside, it really is difficult to figure out what the market potential actually is. Today’s total global internet usage is estimated at 2.45 billion users. So theoretically even at 100% global saturation their market potential today is only 2.7 times bigger than their existing user base. Not very exciting. (Though of course that internet penetration is set to grow). But based on that fact alone I can’t help feel the market potential answer lies elsewhere and there are two recurring hypotheses floating around that I keep stumbling across: personal data and mobile.

    There are over 500,000 apps available through Apple alone. When you download these apps many of them ask if you would like to automatically populate your personal data using your FB profile information. Once you do this and unless you opt out, FB has tabs on everything you do with that app. Not only that, much of the output from these apps also ends up being posted on on Facebook – Instagram being a good example.

    That makes FB invaluable to making apps work usefully (by allowing people to share what they’re doing with them) and gives FB unprecedented levels of information about the activities of the 900 million users they already have. The fact that Zuckerberg recently bought Instagram for $1billion without consulting anyone else at FBHQ in a deal that was (allegedly) agreed over a weekend might also suggest something’s up on this front. That’s a 3 year old company with 13 employees by the way. Nice little earner.

    Such is the importance of being able to link new apps to FB profiles that pundits are saying to attempt to launch an app without this compatibility consigns it to an immediate death.

    Along with this, smartphone and tablet internet use is being seen by many as the big growth areas. And given that many people appear to be so addicted to their mobile devices they can’t walk down a street without gazing down at one as opposed to looking where they’re going, it feels believable. It also makes intuitive sense when thinking about emerging markets: it’s presumably easier to get smartphones into people’s hands than a desktop computer.

    And with your 3G, 4G and wi-fi enabled trusty device in your hands literally 24-7 (including during sex for some people, according to a recent survey) people are never more than a click away from updating their status, Tweeting, Pinteresting, Checking In or Four Squaring. All of which only adds to the frightening levels of information about your life that’s being soaked up on servers somewhere in Palo Alto.

    So, without the benefit of a crystal ball, it feels to me as though the future for Facebook – and therefore real value – might be heavily linked in to what their users are doing (data) and how they are accessing the internet (mobile). Advertising may very well be way down their list of priorities.

    Either way, it all makes you wonder what’ll be next on Zuckerberg’s shopping list.

  3. rob says:

    Paul,

    Agree, it’s a crazy valuation it’s P/E is over 100, definitely a ‘brave’ purchase. Although some tech stocks have come good – Google IPOed with a p/e of 68 – http://www.quora.com/Google/What-P-E-ratio-did-Google-IPO-at – and is now closer to 18 even as the stock has increased from $85 to $600. Back before Google IPOed it wasn’t clear that they would be able to monetize as well as they have.

    I’m not sure FB actually care that much about the current valuation and trying to live up to it. Zuckerberg still has something like 56% of the voting rights making him immune to a boardroom coup and they stated clearly in the S1 filing that – “Simply put: we don’t build services to make money; we make money to build better services”.

    This is probably their best defence against a competitor eating their lunch and the solution to creating long term value, one of the arguments as to why MySpace got taken out by FB was (amongst many things) because they spent too much time thinking about quick monetization and ads which led to them either not developing the product or optimising it for ads not the user – you could make a similar argument about Scully at Apple, he forgot about the products which almost destroyed the company.

    I think they’ve been forced into an IPO they didn’t necessarily want by the SEC 500 shareholders rule and Mr Market has got carried away.

    Interestingly, the revenues are not all about advertising – 17% comes from payments and fees (from people buying virtual sheep on Farmville etc) – http://techcrunch.com/2012/04/23/zynga-made-up-15-of-facebooks-revenue-in-q1-down-from-19-a-year-ago/

  4. rob says:

    i think the letter from Zuckerberg is quite telling – http://sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm#toc287954_10 (page might take a second to jump down to the letter)

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