Losing Face

(eToro Blog) Do you remember what happened on May 18th 2012? Of course you do; that was the date of the long-awaited Facebook Initial Public Offering, which looked then to be most promising launch of any IPO in recent years. The road show that Facebook management staged in the days ahead of the IPO held us in thrall, but we were enraptured right from the start. It was as exciting and glamorous as any Hollywood rags to riches story, with Facebook founder Mark Zuckerberg – Geek Extraordinaire – playing the lead role. Potential investors and everyday Facebook users alike were certain that Facebook was going to be the next big thing – move over Google and Apple – it was Facebook’s turn on the red carpet! All that hype was not unnoticed by the beady-eyed Wall Street sharks which drove the IPO’s target price sky high. The Facebook IPO was on track to become a record breaker – if it could raise the estimated $100 billion in capital Facebook would be written up as the largest tech-based IPO ever. But as we all know now, Facebook’s IPO fizzled instead of sizzled. Instead of Titanic, we got Water World. Facebook’s IPO was no blockbuster, it was simply a bust, and the IPO price of $38 plunged to $18.03, a fall of 52% which lowered Facebook’s value by more than $50 billion.

The Mobile Miss

So what happened? Why were investors selling off newly minted Facebook shares without even the smallest inkling of bad news? Well, it might have been a factor of already existing profitability issues; Facebook is far more expensive than Google or Apple if you consider their respective earnings multiples. Facebook’s P/E ratio is at 40X while Google’s and Apple’s is 16X. Why is Facebook’s so high then? Simply, it’s indicative of higher growth expectations. But the numbers tell the real story; Facebook’s advertising revenue grew only 18% in the second quarter, a substantial drop from 32% growth in the first quarter; that was pretty disappointing for “supposedly” the next Apple or Google.  At a measly 5%, Facebook failed to gain any substantial market share in online advertising; comparatively, Google alone accounts for more than half 50% of all online ads revenue. Even more worrying, a recent Barclays report suggests that social media has a long way to go to prove their worth to potential clients. The results of a very extensive survey conducted by Barclays analysts suggests that big advertisers are dubious of the efficacy of advertising on social media websites, and question their return on investment. To me, those survey results are a cause for great concern.

But there’s more to the story than just disappointing revenue growth. Facebook is taking a beating from Wall Street because they missed an opportunity that they shouldn’t have, and moreover it was an opportunity that they simply couldn’t afford to miss. As Facebook’s key competition, Google has obviously turned the mobile market on its proverbial ear; it has a #1 rated mobile platform in its Android operating system, and a whole host of user-friendly Applications like Google Wallet and Google Drive. To say that Facebook has lagged well behind Google would be a gross understatement; the fact is that Facebook management pretty much missed the entire mobile revolution. And this wasn’t a little, just-off-the-mark kind of miss, this in fact was a huge, didn’t-you-even-see-the-target kind of miss. Facebook simply cannot afford to make those kinds of misses. In comparison to Google’s trail-blazing efforts in the mobile arena, Facebook’s mobile apps seemed slow and immature and users quickly turned away in favor of other cutting-edge mobile applications.

But there’s more to come; according to tech and gaming analysts, Zynga, Facebook’s social gaming company which draws most of Facebook’s revenue stream, is likely to see a drop of some 6 million daily users by the end of the year, with users turning instead to mobile game apps. Following in Facebook’s footsteps, Zynga is being left in the dust by the other big name gaming companies, further jeopardizing Facebook revenues. Earlier this week, Tokyo was the site of a huge gaming convention which drew more than 200,000 visitors. More than 40% of the gaming convention exhibitors, which included the world’s largest game makers, had a strong mobile presence. Guess which gaming company was notably absent?

The Zuckerberg Question

It could be argued that Facebook is still young and that it’s a dynamic company that is merely suffering from a few setbacks. But I don’t believe that that is the case at all. I believe that for the reasons listed below the company is headed for a decline.

• Facebook failed to capture the growing segment of mobile users by failing to make the shift to mobile-based operating systems and applications.
• Despite Facebook’s legacy as the world’s second most visited website, the company couldn’t even obtain a double digit share of online advertising revenue.
• Facebook lacks a strong presence in mobile gaming.
• More importantly, Facebook failed to craft a strategy that could monetize its enormous user base.
• Finally, the company didn’t make good use of its cash reserves to try and enter market segments it needed a presence in; in the case of Instagram, it only purchased the company in fear of losing control of the photo sharing business.

I believe that many of Facebook’s problems could be addressed head on with a more aggressive management team. Facebook needs leadership which could create strong pricing models, lead aggressive takeovers and ultimately build a much stronger foundation. Facebook management needs to work to dominate market share instead of allowing the erosion of its revenue base. Simply put, what Facebook urgently needs is a new CEO. It’s certain that Facebook would not have become the Facebook we know and love without Mark Zuckerberg, and he should undoubtedly continue to play a key role. But until Facebook hires a professional, high profile CEO – of Eric Schmidt’s ilk – then Facebook will be forced inexorably to the margins by Google and Apple. Will a new CEO be on the horizon, who could restore value to the world’s largest network? That’s a good question but only time will tell.

Copyright 2012 eToro Blog