Friday 5 September 2008

Facebook--Is It Commercially More Than a Bunch of Pretty Faces?

So is social networking the next big thing? Ever since Google's triumphant IPO and meteoric growth in online advertising revenues, pundits have been looking for the next big thing (even if we are talking about a time-line of only several years). Skype and YouTube have not quite panned out, but the explosion of MySpace and then Facebook has focused attention on the growth potential in social networking.

There is no doubt that participation in social networking continues to grow (although my memory tells me that there have reports of a slow-down, or at least a deceleration in the rate of growth of U.S. users of social networking sites). Another possibly telling sign was reported in August 18th issue of Business Week. In an article entitled "Has Facebook's Value Taken a Hit?", the author describes unsubstantiated reports that insiders, including at the highest level of management, have been putting up their shares fore sale in the still-private company. The supposed purchasers of the shares are various funds and institutional investors.

If true, it is unusual for this kind of sale of shares by insiders to take place in the context of a start-up, especially one as lauded and applauded as Facebook. More typically, such shareholders hold onto their equity until a public offering or sale of the company takes place. A further downside to the report is that it has alleged led to employee grumbling. To remedy such possible dissension, Facebook apparently has developed a one-time program to allow employees with vested share options to realize a portion (20%) of their holdings.

There is an interesting company valuation issue here. When Microsoft purchased a small equity stake in Facebook in October 2007 ($240 million for 1.6% of preferred stock), the two companies implied a valuation of $15 billion. However, the plan enabling employees to realize a portion of their vested stock options is based on a $4 billion valuation. Indeed, it is reported that departing employees will be subject to certain restrictions should they then seek to sell their shares. One of the conditions is that they will permitted to sell their shares for no more than a $3.75 billion company valuation.

Has Facebook Suffered a Valuation Drought?

What does this all mean? In particular, do such sales reflect merely doubts about the short and middle term prospects for shareholders to cash out, due to the deteriorating status of the capital and equity markets, or does it also reflect doubts about the ultimate long-term prospects for the company in the so-called "real economy"? I.e., how will Facebook make money from its site, whether from ads or elsewhere?

Facebook can perhaps take some solace in the fact that when I tried to elaborate on this question with my 20-something son, he simply shrugged his shoulders and returned to embellish his own Facebook site.

Facebook Facing the Music

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