Facebook’s hilariously botched IPO has provided no shortage of amusement and anger in the investing community — sometimes both at the same time. Still, this is a world where paradigm-changing technologies more than 20 years old are often referred to as “dinosaurs” and the Cult of the New is often mistaken for common sense. Amused or angry or both, Facebook’s transformational entry into all aspects of social connectedness made it undeniably intriguing when it went public. It emphasized a series of existing questions about Facebook — questions about the fundamental and economic value of human relationships, about the degree to which people would willingly allow their relationships to be mediated by a business, and about the effect of technology on young and developing minds. And it blurred the hell out of the line between what is public and what is private.
From an investment standpoint, I have been cynical about Facebook as a publicly traded company since the first day I heard of its IPO plan. The post-IPO drama supported my cynicism, but after the company’s Q2 earnings report there has been a significant turnaround in investor sentiment. In Facebook’s defense, they did have an absolutely amazing quarter, jumping from a few pennies’ earnings per share to $0.19 per share, and slashing their P/E ratio by almost 90% (90%!). But, being an unabashed value investor, I remain cynical. Here’s why:
1. Even with their radically reduced Price-to-Earnings (P/E) ratio, Facebook would require about 180 years of equivalently awesome performance to earn its current market cap. A hundred and eighty years is a hell of a lot better than the nearly 2-millenia recoup time of its previous earnings period, but it’s still a long time — long enough for most governments to be established, grow stale, and then collapse again.
2. Barring the discovery of wormholes leading to large human populations on other planets, Facebook’s user base — which stands at about 1.15 billion — will lack any room for aggressive expansion. There will simply be no one left to sign up. Slowing expansion of user base means lower expansion of revenues.
3. And here’s the kicker: Facebook managed to maximize its revenues last quarter only by following a time-honored (a la “dinosaurs”) monetization technique — specially, soak a dedicated user-base in as many advertisements as they can stand. This isn’t innovation; it’s cashing in on a captive audience, and it has consequences for user satisfaction and retention, especially in a market that is chalk-full of competition.
Look at it this way: imagine that every relationship you have is a television show, and imagine that for several years you have been watching these television shows on a premium cable network with no advertisements, filtration, or sponsored messages. Then, gradually, commercials begin appearing — at first only rarely, but then with increasingly metronomic frequency. Then some content starts disappearing — like the Discovery Channel’s fake documentaries, the network realizes that the truth doesn’t sell and starts pitching more attractive nonsense. Then — the coup de gras — the network starts slipping advertisements into our programming by disguising them as content, in what can only be called the ultimate product placement scheme. It’s like a gradual transition from HBO and STARZ to OXY and QVC.
There’s nothing new in the technique. This is a process that’s been applied to television in a thousand different variantions since its advent, and it’s been applied to the idea of intellectualism and “serious” thinking in modern academia and to technical expertise across dozens of fields in the last fifty years. But there’s a difference. In the case of visual media we are largely incapable of producing the type of content we desire by ourselves, and so we’re usually willing to endure some mercantile punishment in order to enjoy our “free” content. In academic and technical fields, the curricula and training model does add content and value. The same is much less true in the case of a social network, where the participants are the content, and the value is derived from relationships between users. Rather than adding value, Facebook has effectively woven itself into a huge swath of our relational spectrum — and now, under the pressure of supporting its valuation, it is “selling” our own relationships back to us with their own messaging embedded.
I don’t mean to villify Facebook at all (I will leave that to others). I find it a very useful tool for keeping track of the broad landscape of my friends, family, and acquaintances — a view from 10,000 feet, if you will. But one thing that Facebook is not — at least, not at this time — is a good business model.