Another dot bubble?

Adrian Weckler wrote an interesting column in the Sunday Business Post this week “Twitter’s $10bn bubble tag”.  It reminded me of a piece I had written and not published about the value put on Facebook after a fund raising:

An investment in Facebook in January valued the company at $50bn.  Investors put $500m into the company presumably in return for a 1% stake.

Facebook plays its cards close to its chest when it comes to disclosing financial information and how it generates income.  Documents leaked last week revealed turnover of $1.2bn and $350m profit in the first 9 months of 2010.  This would indicate annual turnover of $1.6bn and a profit of $467m. 

This puts the value of the company at a staggering 107 times its current annual earnings.  The value must therefore be based on the future potential of the company.  It suggests that Facebook is predicting rapid income growth and, probably more importantly, widening of its revenue base beyond advertising.  The investors must believe Facebook’s predictions are possible.

The only apparent revenue that Facebook generates is advertising income.  It claims to have over 500 million “active” users.  Active is defined as having returned to the site in the last 30 days.  Based on estimated turnover of $1.6bn, each user generates $3.20 each year – presumably by clicking on advertisements.  If you analyse growth in active users since Facebook’s launch in 2004 it looks as though the rate of growth has peaked and is now in decline.  It follows that if the rate of growth continues to decline, sooner or later it will enter negative territory which means that the number of active users will decline.  Facebook needs to have ways to keep users active.

My experience of new Facebook users is that they tend to be over-enthusiastic on first signing up then soon become bored and post less often.  While this does not necessarily mean they become less active (ie they don’t reduce visiting frequency) it does indicate that they spend less time on the site, and therefore are less likely to notice advertisements.

In my opinion, for the $50bn price tag to be justified, Facebook needs to address the declining growth rate of active users.   It can do this by offering new services to retain existing users and attract new users who have no interest in Facebook as it stands.  It then needs to either extract revenue directly from these users or use them to generate income from third parties.  It would need to be something radical to justify the price/earnings ratio of 107.  It should also be mindful of Bebo and how fickle people can be.  Something might appear tomorrow that will wipe the floor with Facebook, before it has the chance to justify its current valuation.

The Financial Times reported at the weekend that Facebook was set to take over the web and that Google is “running scared”.  But no-one seems to know how it will do this and generate income from it.

More and more businesses are awakening to the benefits of social media for marketing and promotion.  It is possible for a business to acquire thousands of followers with little or no outlay (other than employee time – which doesn’t generate any income for Facebook).  I think businesses can gain better quality exposure by gaining followers status updates than by paying for advertisements to promote awareness.  Especially where a business can give, relevant and useful information to existing and potential customers.  It gives businesses the opportunity to demonstrate their human side which advertising may not be able to do.

A major downside for Facebook advertising is that people don’t use Facebook to find suppliers.  Compare this with Google adwords where the user is actually looking for the product or service that has been targeted at them (provided of course the advertiser has selected its keywords carefully). 

This leads me to conclude that Facebook advertising is very limited.  Therefore, it must have something truly magnificent up its sleeve if it is to generate the kind of revenues needed to justify the value recently put on it by investors.  We can only wait and see what that might be.  The alternative is the start of another dotcom bubble.  One lesson that has been learned from “bubbles” is that people don’t learn from them.  They always think that this time is different than the last.  Time will tell.

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