Opinion: Why Facebook is worth a dollar a year... and falling
Stratospheric valuations aside, what is Facebook really worth? Computing Editor Chris Middleton explains why it has never been free to use
Shortly, Facebook will rewrite the rule book for IPOs with its oversubscribed offering that values the company – in the terms it has set itself – at north of $100bn. To get to this point, Facebook has become a byword for an activity, a tool that is core to organising people's lives.
Make no mistake, Zuckerberg's achievement is stunning in business and cultural terms: for a startup to go from nothing to more than 900 million users and a stratospheric IPO is astonishing within any timescale. To do it in eight years from a standing start is unprecedented. Today, Facebook is the app or platform equivalent of the mobile phone, the desktop PC, in terms of its global user base.
But away from the ticker-tape parade, what is Facebook's underlying value? The core asset of a social network must be its users, and so it is reasonable to ask what each of those 'assets' is currently worth to the company. The answer is: $1. One hundred cents.
The core asset of a social network must be its users, and so it is reasonable to ask what each of those assets is worth.
For the sake of argument, let us suppose that Facebook has one billion users – it will soon, according to its own figures – and a theoretical market capitalisation of roughly $100bn – again, according to its own valuation. Of course, a market capitalisation of $100bn divided by one billion users means that each Facebook user is worth $100 to the company's investors. Not bad, you might think.
But now look at Facebook's financial performance. In fiscal 2011, Facebook's net income, it said, was $1bn. If that figure is correct, then in pure profit terms each of those one billion users (again, for the sake of argument) is only worth $1.
Let's spell that out: in the real world, Facebook currently makes roughly $1 per user a year. And falling, according to its most recent 2012 results, which showed a significant drop in profits. Replace the word 'user' with 'customer' and the size of Zuckerberg's problem becomes apparent.
Of course, the exact numbers are different and Facebook had fewer users in 2010-2011, but the principle stands: its market value is many, many times greater than its annual profitability, according to its own figures. That massive chasm needs to be closed for investors to stay onboard.
Users, meanwhile, don't care.
This, then, is the underlying problem for the company. The stock market says that each user is worth $100 to the company's investors, but its financial performance says otherwise. The tough reality is that each user is worth a tiny fraction of that amount in monetary terms – give or take a few real-world cents. And none of them care.
And as Facebook's user base grows past our notional one billion mark, the monetary value per user will actually fall – unless it can drive up its profits and its share price much faster than its user base is growing.
But how?
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Opinion: Why Facebook is worth a dollar a year... and falling
Stratospheric valuations aside, what is Facebook really worth? Computing Editor Chris Middleton explains why it has never been free to use
To do that, Facebook needs to behave like a mature business, and one that has a clear roadmap for its future development. After all, it is one thing to facilitate conversations, but quite another to monetise them.
At heart, Facebook connects people, and so its core business ought to be monetising connections, or Likes, not selling advertising to them. The advertising model isn't working (see our separate news story) – at least not well enough for a $100bn business, and certainly not one that plans to become increasingly mobile.
So what might Facebook 2015 look like? A future of mobile superdistribution, perhaps? Of incentivising its users to share content with their friends – like Pinterest with payback? Or a future in crowdsourcing and funding bright ideas, along the lines of Kickstarter or Sponsume?
The core asset of a social network must be its users, and so it is reasonable to ask what each of those assets is worth.
The problem for Facebook is that its choices are legion and it will soon have the money to make all of them. Complexity is something the cluttered Facebook experience needs like a hole in the head, especially when users are signed into a walled-garden platform.
This is where Facebook's roadmap is far from obvious. There is no hard evidence that Facebook users will pay to make connections with their friends – at least, not beyond the mobile voice calls they already make, and not when the point of Facebook's service is that it is “free” to use.
The social network's fans say that people shouldn't criticise Facebook – its constant meddling with its interface, for example (something that Apple, Google and Twitter know not to do) – because it's a free tool.
Except that it isn't, of course. We all pay for it with the only currency that matters in the 21st century: our data, our friend networks, our Likes and (that great missing function) dislikes, all the things we have allowed Facebook to turn into a $100bn flotation.
(Even the UK government knows that personal data is the only hard currency today; it's the real reason it wants access to it, under the guise of 'national security'. What they mean is 'economic security'.)
So if Facebook already has over 900 million 'small data investors' and rising, how does it plan to sell 'us'?
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Opinion: Why Facebook is worth a dollar a year... and falling
Stratospheric valuations aside, what is Facebook really worth? Computing Editor Chris Middleton explains why it has never been free to use
So far, the signs of Facebook becoming a mature business are in short supply. Immediately pre-IPO, Facebook set about spending to accumulate. Buying Instagram made some sense and gave the company a trojan horse for entering the Chinese market. However, buying it for twice its pre-purchase valuation seemed very 'new money'. It said, “We can spend a billion dollars”, and on an app that has no revenue model.
Of course, all tech money is 'new money' unless you have a century of tradition like IBM. But the Instagram deal was the kind that created its own gravity, bending the market around it. That spells immaturity, risk and distortion in a fragile economic environment for those businesses that actually make more than $1 per user a year.
The world economy needs success – and Facebook is a success – but it does not need any more disparity and distortions than it already has.
The core asset of a social network must be its users, and so it is reasonable to ask what each of those assets is worth.
Then Facebook set about buying ideas in the shape of a raft of ex-AOL patents from Microsoft and, with its IPO already scorchingly hot, launching the kinds of projects that a more mature business would grow its share price with over time: an App Center, the acquisition of Lightbox, and so on.
The impression is of a company throwing everything at its IPO, and not at its vision; a start-up trying to push 30 years' of strategic expansion into 30 days. It looks immature – a game of Monopoly with plastic ideas.
The financial effect has been to build a vertiginous financial cliff for the company's IPO. So now the company must prove that it can use that precipice to take off on a long-haul journey that it has clearly advertised, carrying investors and users with it. The alternative is to jump off it and spiral slowly to the ground, holding the data of a billion people.
To fly, it needs a clear vision of who it is, and what it does with the $16bn or more that it may raise from the shares it is selling. But the flaws in its business model today suggest there is no guarantee of success tomorrow, at least not if it wants its millions of users to stay onboard for the ride.
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Opinion: Why Facebook is worth a dollar a year... and falling
Stratospheric valuations aside, what is Facebook really worth? Computing Editor Chris Middleton explains why it has never been free to use
It needs a future that those users support – given that they pay for it with their data – and not just the minority who have spent money on shares.
If nothing else, Facebook's IPO is proof of America's longstanding ability to hothouse domestic talent via a portfolio investment culture – something that is beyond the scope of the UK's self-absorbed financial community, which makes money either from the government breaking off bits of the state and flogging them, or from investing in investment itself.
The UK economy is too busy consuming itself in ever-decreasing circles to truly create the kind of tech investment culture the US still nurtures so well.
The core asset of a social network must be its users, and so it is reasonable to ask what each of those assets is worth.
But people like the Facebook of today. With all its irritating flaws, clunky interface, constant meddling and deteriorating design values, we still use it. Some of us rely on it and organise our lives, businesses and passions around it. It has found its way into the core of people's lives with stunning speed. This is the real reason why the people that use it today are backing the Facebook of tomorrow with their hard-earned cash. Nothing succeeds like success.
But most of them probably have no idea of its long-term strategic business vision. Why would they? It's not clear, yet, that Facebook has either.
But its users – every single one of them – have already invested in it with the things that are most important to them. So now Facebook needs to repay their faith, and not just the market's.