Facebook's dotcom adventure may yet fail spectacularly

By Stephen Foley

When is a $100m gift not a $100m gift? When it's in Facebook stock. I am absolutely not going to join the chorus of cynicism that has greeted the Facebook founder Mark Zuckerberg's announcement - on Oprah Winfrey's show, on the eve of the release of the critical movie about Facebook, The Social Network - of a major donation to the school system in Newark, one of the worst in the country.

Improving the blighted schools of America's inner cities offers perhaps the greatest leverage for domestic philanthropy, and Mr Zuckerberg, whose girlfriend trained as a teacher, has been genuinely invested in the issue and persuaded of the transformative powers of Newark's charismatic mayor, Corey Booker. It is unequivocally a wonderful gift.

But is it worth $100m? Mr Zuckerberg's Startup: Education foundation is being seeded with Facebook stock, but Newark would be wise to turn the promise into cash right away.

Facebook's valuation, vacillating in recent months between $23bn and $33bn, is highly speculative and almost certainly too high.

Facebook is not traded on the stock market. Those valuations are based on the price fetched for the very small number of shares that trade on a secondary market, where departing employees can cash out and eager venture capitalists can buy in.

When Facebook will properly float, and its valuation be subjected to the rigour of a bigger market, is one of the white-hot debates of the tech industry.

Despite being embedded in so many of our lives, and despite passing 500 million user profiles, the company is expected to bring in revenues of no more than $2bn this year and, with the costs of staff and servers rising in line with users, it is not clear it is making much real profit on that yet.

It seems counter-intuitive, but it is entirely possible that a company seen by maybe half of all the world's internet users might be worth very little.

Facebook doesn't charge its users. It also makes little money from the third-party applications users add to their profiles. It has recently been talking up the prospects of turning Facebook Credits into a virtual currency, on which it takes a 30 per cent cut, for use across the web, but I'd be wary of financial regulators sniffing around if this does take off.

As for selling access to the data it collects from its hundreds of millions of users, privacy concerns have put a cap on those ambitions.

None of this is to say it won't find a way, but a valuation of more than 10 times revenue, and God knows how many times earnings, seems racy, to put it mildly, unless there is a clear business model. I would not put any of my money into Facebook at this point, unless I could afford the risk of losing it all.

It is the job of venture capitalists, who seems to be the main buyers of Facebook on the secondary market, to make big punts like this. Stock market investors, including mutual funds entrusted with our pensions, will probably want to wait, which is why a flotation could be further off than is imagined. This isn't the dotcom boom, after all.

Google has a lot to answer for. Its founders focused on building the world's best search engine, not on building a profitable company. The business model came later, selling what are still the most effective kind of ads on the web, alongside search results.

This "build now, business later" approach is typical of most of the big internet sensations of the past few years, but it fails more often than it succeeds (even at Google, which acquired YouTube halfway through the video sharing site's build phase and has failed to make money on the deal).

The exact nature of the funding promises made by Startup: Education to Newark was not immediately clear yesterday, but let's hope the schools get to cash in their gift as soon as possible. It will take years for Facebook to really justify its supposed valuation, until which time its thinly traded stock could halve or worse at any moment. Or go to zero. Remember that the jury is still out.

Facebook might yet turn out to have been a wonderful experiment that, in an economic sense, was simply a misallocation of capital by its venture capital backers. In layman's terms, a waste of money.

- THE INDEPENDENT

© Copyright 2014, APN New Zealand Limited

Assembled by: (static) on production apcf05 at 29 Dec 2014 00:42:11 Processing Time: 331ms