A Ludicrous Value Proposition, If Not From Facebook

Some weeks ago, I happened to drive by an evangelistic church whose outdoor marquis speaks about as well of the present times as any I’ve come across. “And there followed hail and fire mixed with blood,” it read, “and they were cast upon the Earth. Like us on Facebook!”

The initial public offering of Facebook stock, now likely to come in May, is as much a test of faith as any corporation has ever given its prospective shareholders. To Facebook’s credit, its prospectus, as given in its Form S-1 filing yesterday, makes its plea completely and carefully. Many companies provide a perfunctory paragraph to investors under the “Risk Factors” heading. Facebook’s entry reads like a self-indictment.

Most of its money is made from a source that is unreliable, with no guarantee of long-term viability. That’s not my second-rate financial analysis of the matter; that’s Facebook’s own explanation. From Facebook’s Form S-1:

The substantial majority of our revenue is currently generated from third parties advertising on Facebook. In 2009, 2010, and 2011, advertising accounted for 98%, 95%, and 85%, respectively, of our revenue. As is common in the industry, our advertisers typically do not have long-term advertising commitments with us. Many of our advertisers spend only a relatively small portion of their overall advertising budget with us. In addition, advertisers may view some of our products, such as sponsored stories and ads with social context, as experimental and unproven. Advertisers will not continue to do business with us, or they will reduce the prices they are willing to pay to advertise with us, if we do not deliver ads and other commercial content in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives.

READ ALSO: Facebook’s Biggest Risks Explained by Dan Rowinski

Sure, it garners some 845 million active users per month. (That’s no longer someone else’s marketing estimate, or some figures from a marketing brochure, but a disclosure that would carry penalties if it were false.) But the reason they’re there is to have fun with each other, which is an activity that unto itself does not generate revenue. What does generate revenue, and certainly more of it now than before, is advertising. But historically, the value of that advertising business was fleeting, only sending the company into the black with $229 million of net income in 2009.

Only in April 2010 – not even two years ago, when Facebook’s user base reached a mere 431 million monthly users – did it actually engineer some way of galvanizing and potentially harvesting its traffic: the Like button. Whereas most consumer products manufacturers since the dawn of history have had only limited success with their own brand-centric, customer outreach programs, along comes a unified, one-button approach to associating one’s identity with a product that consumers would actually want to use. Potential future shareholders who already felt Facebook’s value proposition was overdue, got their answer in spades. “Like” is perhaps one of the most successful customer outreach initiatives in all of global corporate history, as important a creation to the evolution of technology as the iPhone.

“Like” is perhaps one of the most successful customer outreach initiatives in all of global corporate history, as important a creation to the evolution of technology as the iPhone.

But its milestone is not nearly as well founded in terra firma. Sure, “Like” has created the mother lode of all consumer intelligence, a nerve center for the personal interests of more people than live in most countries. How to monetize that creation remains a topic with a question mark at the end. Advertising is the most obvious route. Yet as Facebook’s own S-1 points out in the most unambiguous language one would ever hope to see from a public corporation, it’s stuck. Most of its users are moving to a mobile platform, one whose usage model is not conducive to advertising.

We had more than 425 million MAUs [monthly active users] who used Facebook mobile products in December 2011. We anticipate that the rate of growth in mobile users will continue to exceed the growth rate of our overall MAUs for the foreseeable future, in part due to our focus on developing mobile products to encourage mobile usage of Facebook. Although the substantial majority of our mobile users also access and engage with Facebook on personal computers where we display advertising, our users could decide to increasingly access our products primarily through mobile devices. We do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven. Accordingly, if users continue to increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, our revenue and financial results may be negatively affected.”

The only quality this explanation lacks is succinctness; it drips with sincerity. Let’s put it like this: The source of 85% of this company’s wealth is in danger of virtual extinction in the next few years: personal computer-based browsing. Sure, you may own a PC in 2014, but there’s a good chance it’ll run Windows 8. And assuming there’s a Facebook “Metro-style” app for Win8 (a safe bet), who will want to use Internet Explorer or Firefox? Users will prefer one usage model for all platforms, and will probably demand the mobile-style model because it’s the easiest to learn, and because it’s portable from device to device.

While gaming makes up most of the other 15% of the company’s revenue, an incredible four-fifths of that chunk comes from one source alone: Zynga, whose Farmville game has addicted tens of millions of virtual farmers in the pursuit of non-existent vegetables and livestock.

So a lot of what sustains this company is image. Again, I’m only mildly rephrasing what the S-1 literally says. The belief that Facebook is a beneficial and productive platform is largely in the public mind. And what stays in the public mind depends, to a surprisingly large extent, upon me. No, not you, me. As in, the person writing articles about Facebook for dozens of you to read.

We have in the past experienced, and we expect that in the future we will continue to experience, media, legislative, or regulatory scrutiny of our decisions regarding user privacy or other issues, which may adversely affect our reputation and brand… Maintaining and enhancing our brand may require us to make substantial investments and these investments may not be successful. If we fail to successfully promote and maintain the Facebook brand or if we incur excessive expenses in this effort, our business and financial results may be adversely affected.

So do invest in us, if you would, please. We thank you for your attention. This is how the prospectus might have ended, if it weren’t for one obvious fact: This is Facebook we’re talking about. While it could have filed for an IPO three or four years ago, back when its business model was not so much cloudy as non-existent, it prudently waited. What Facebook has now are the ingredients for something huge. It has the talent, it has the technology, and it certainly has the audience.

But, to borrow a term from football, it must convert. The scale of this conversion must be enormous, otherwise the tower of cards, as Facebook describes itself, will fall. What form could this conversion take? Imagine a mobile platform where not only is one’s entire social activity portable, in the cloud, moving from device to device – from smartphone to tablet to PC to TV – but one’s functionality as well. Think of Facebook encapsulating everything that people do with computing or, as Salesforce’s CEO puts it, Facebook eating the Web. It is not outside the realm of feasibility.

It is indeed possible to believe. All you need are about $5 billion in fresh investor capital, and a miracle straight out of Revelations.

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