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Hype versus reality: Fundamental value will determine ultimate success of Facebook’s IPO

In late May, the markets took on what, along with Google, was the most hyped IPO in the post- dotcom, post-Enron era. By most accounts, it was a colossal flop. At the time of writing this blog post, the Wall Street Journal is reporting that shares of Facebook are off 24 percent since the IPO.

Anyone can point to myriad reasons why the IPO didn’t live up to the hype and many of them have already been stated repeatedly in the press, but the one question we really need to ask ourselves is “Did the IPO really go as badly as it’s being depicted in the press?” The answer is decidedly “No, it did not.”

According to Bloomberg, the Facebook IPO raised $16 billion, making it the second largest in U.S. history. This is an astronomical figure in the sense that it actually puts the company trading at about 100 times earnings at the close of its first day of trading.

What seems to have occurred, however, is that the press and the public have learned little or nothing from the dotcom bubble bursting, and our expectations around what an IPO should be like are still jaded. At the end of the day, fundamentals must still rule and, once the initial IPO hype subsides, markets and valuations will be governed by those fundamentals.

Beyond what is arguably an inflated PE ratio that’s currently sitting at about 52 percent, a number of key issues handicapped this IPO from the start.

First, Facebook has a brand image issue that has not been adequately addressed. Unlike Google, the Facebook brand is undeniably tied to its founder, Mark Zuckerberg. In the past few years, Zuckerberg has faced some significant image problems over how Facebook came to be and, more recently, that the IPO itself was simply a vehicle for him to “cash out.” Regardless of the degree of truth to these perceptions, Facebook has not done a good job of neutralizing and diffusing these issues from a public relations standpoint. Couple this with continuing issues surrounding privacy, and you have a brand that is less than polished.

Second, Facebook is really a “one trick pony” when it comes to revenue. Facebook makes approximately 85 percent of its revenue from advertising. The bulk of the remaining 15 percent comes through payments for virtual goods. While this revenue model is almost identical to Google, the challenge Facebook has is that, unlike Google, it has only a single channel for ad delivery. The company has been unsuccessful in delivering banner ads through its mobile app or through acquired functionality (like Google does with YouTube).

On a more fundamental level, Facebook has not yet understood the basics of Internet advertising. Traditional advertising is based on the premise that a consumer is engaged enough in content to tolerate an interruption (i.e., an ad) and then continue viewing the content after the interruption. This model no longer prevails on the Internet. The ad itself must contain engaging content or users will simply move on and find their content somewhere else on the web. The ineffectiveness of Facebook’s “banner” and “purchased page” advertising model was highlighted days before the IPO when GM announced that its Facebook advertising campaign had been ineffective.

While revenue is a key market driver, revenue growth is also of paramount importance. In the quarter ending December 2011, Facebook revenues were an impressive $1.1 billion. This is up from about $950 million from the previous quarter. On the surface, this seems pretty impressive. However, these numbers represent an enormous year-over-year decline in growth from 100 percent to about 55 percent. With the number of users signing up per month decreasing and Facebook’s lack of success in building new advertising delivery channels, there is no evidence to suggest that Facebook is capable of stopping this slide.

When all of these factors are taken into account, raising $16 billon and trading at 100 times valuation on the first day of trading doesn’t seem so bad after all. Outside of the context of the IPO, the stock price of Facebook will, ultimately, be determined by the company’s ability to correct, adapt and grow, and not by the hype surrounding it.

At the end of the day, don’t always believe the good or bad press when they say an IPO is a success or a disaster. Ultimately, it comes down to basic fundamentals and value for money.

Comments

Great blog Brian, I agree that Facebook has not yet understood the basics of Internet advertising. I was reading another blog where FB misunderstood sarcasm for an endorsement...there are so many ridiculous ads that turn into likes and suddenly go viral. FB has a long way to go before it reaches the likes of marketing such as Apple as it is so often compared to with regards to advertising.

Here's the site I referred to;

http://finance.yahoo.com/news/facebook-likes-become-ads-101815773.html
Soma

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