Facebook Reaches a Crossroads
Christopher is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It wasn't long ago when Facebook (NASDAQ: FB) was the toast of both Silicon Valley and Wall Street. It was the most popular company in the rapidly growing social media industry, a welcome oasis for investors who had been rocked by a decade of low returns and little excitement. The big fish were desperate to get a piece of the action, driving up the market value of Facebook on secondary markets to $100 billion, and when the IPO was finally announced with much fanfare, everyday investors would finally get a chance to join the fun as well.
Of course, all honeymoons must eventually come to an end, but Facebook's romance with investors was shockingly brief. Whether it was CEO Mark Zuckerberg showing up at an investors' meeting in a hoodie or the disaster that was Facebook's opening day of trading, the darling of the Internet has quickly become the ugly stepchild.
The irony, of course, is that Zuckerberg never truly wanted to bring the company public, but even he could not ignore the constant exhortations from employees and venture capitalists who were looking to cash in on their paper profits. Unfortunately for him, most of his worst fears about being a public company, including the intense public scrutiny from an investing community that is oriented toward short-term thinking, have come to fruition.
Although Zuckerberg has no prior experience as a public executive, he is quickly coming to appreciate a fundamental tenet of Wall Street: When it rains, it pours. After Facebook failed to adequately excite investors with its first-ever quarterly earnings report – which did exceed analysts' revenue forecasts – investors pounded the stock to the psychologically important barrier of $20 per share.
With an IPO price of $38 per share, investors who were once desperate to pile into the stock are now coming depressingly close to a 50 percent loss on their initial investment. Even worse, there does not seem to be anything in Facebook's future that would provide any impetus to arrest this decline. Instead, the steady drumbeat of bad news has continued to punish the stock to new all-time lows.
The latest salvo in this seemingly never-ending attack of negative press has come from a little-known start-up that has made a big splash in recent days. The company, Limited Run, made the provocative claim that more than 80 percent of the clicks from its advertising campaign with Facebook came from robots, not real people.
For a company that derives 84 percent of its total revenue from advertising, this is a serious claim that could undermine advertisers' confidence in Facebook's advertising platform. Indeed, this is not the first time that a company questioned the efficacy of advertising on Facebook: In a very inopportune moment just days before Facebook's IPO, General Motors (NYSE: GM) announced that it was pulling its $10 million advertising campaign, citing a lack of adequate return on its investment.
This was not the way that things were supposed to go. Google (NASDAQ: GOOG) had already proven that advertising could work on the Internet – almost all of its $38 billion in revenue comes from its ubiquitous advertising network – and Facebook seemingly had the ability to take that to the next level. With its wealth of personal information on its 955 million active users – 83 million of which Facebook is now admitting are probably from fake or duplicate accounts – the company could target advertising to its user base in a way that Google was incapable of replicating. Alas, advertising profits have not come quite so easily.
Even worse, more of Facebook's users are migrating to mobile devices, which has been a notoriously difficult medium to monetize with advertising. Zuckerberg has been adamant in emphasizing Facebook's user experience over its profitability, but the costs of that strategy may become too great to overcome in the near future – it is rather difficult to place enough advertising on a mobile site without unduly distracting visitors.
Of course, Facebook is no Myspace: The company is an Internet juggernaut that benefits from network effects that make even Twitter envious. Facebook brought in more than $1 billion in revenues during the second quarter, and the company is sitting on a $10 billion cash cushion, which will certainly help protect them as they attempt to develop a comprehensive mobile strategy.
The problem is that Facebook has simply become a victim of its own hype. Investors had visions of rapid user growth for as far as the eye could see, and they bid up valuations based on those rosy projections. The company is still trading at more than 70 times earnings, but there is evidence suggesting that Facebook has already begun to saturate its market; for instance, year-over-year user growth in April increased by an anemic 5 percent.
Although online adverting spending still only accounts for approximately 11 percent of total global advertising, Facebook will ultimately have to find a way to better monetize its existing user base. Ideally, Facebook would be able to diversify its revenue streams in the same way that has made LinkedIn so popular among investors, but its future seems almost inexorably tied to advertising – and Zynga. If Facebook fails to extract more profits from its quickly maturing business, it could have a difficult time justifying its valuation, even at these lower levels.
cjcoyle has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Google. Motley Fool newsletter services recommend Facebook, General Motors Company, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.