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A Longer-Term Look at Facebook

As the IPO recedes, here are key issues for the months ahead

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Pulling rabbits out of the … hoodie. Buying FB in the open market — aside from short-term trading that ignores fundamentals — is banking on its future creativity. As it stands, FB’s revenue model is selling ads — highly targeted ads based on tons of user information freely offered by the people being marketed to. However, if this remains the sole or primary source of revenue, it’ll make FB a media company with social networking only the means to the end as far as Wall Street is concerned. It will be graded by time-tested metrics, tailored slightly to its business model.

However, if FB can figure out how to turn its unique networking platform into something more than ad-selling — how to use its potential for data aggregation, broad-based collaborations or new services available only through FB that users would happily pay for in the same way they pay for phone or cable — then the Street will have to reevaluate its models to account for FB’s extremely sticky 900 million user base.

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Currently, with a $4 billion top line, FB is making only 37 cents per month from each user, or $1.11 per quarter. No doubt, there’s is potential for significant growth. But to realize the kind of growth rates implied in the IPO pricing, new revenue streams are going to have to materialize. It’s difficult to imagine that ad selling — even highly targeted ads — will accelerate to the degree needed to support these valuations. Lots of gold is buried in Facebook’s hills, but digging it out in traditional fashion could turn the landscape ugly.

It will hinge largely on Zuckerberg and FB’s hacker ethos to sleuth out ways to mine that gold without disrupting the social intimacy and personal choice that keeps Facebook alluring to its users. If FB becomes a pure ad seller, even a premier ad seller, the IPO price will turn out to be way too rich. But if it figures out how to extract its riches without disturbing its beauty, then the current price may eventually be seen as a bargain.

The FB culture: long term over short term. Investors who did receive some allocation in the IPO and were looking for a quick, handsome gain will get no sympathy from FB if the stock keeps heading south. Zuckerberg & Co. have always emphasized their concern for realizing long-term vision over making appeasements to short term obstacles. (Note how every new change to Facebook’s layout or news feed is met with resistance and grumbling from users, but eventually helps bolster long-term growth rates.)

For what FB wants to accomplish, boosting the IPO price to $38 in the final stages before trading was a strategic move. Its motive was to raise more cash for its projects, not help speculators get an quick outsize return. In this sense, the IPO was perfectly in line with FB’s philosophy. As Zuckerberg said in a letter prospective investors: “We don’t build better services to make money; we make money to build better services. And we think this is a good way to build something. These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits.” (Italics ours.)

That’s a crucial admission, and you should be sure you’re aligned with it if you decide to invest in FB for the long haul. (See #1 and #2.)

If you’re looking for fast money, FB could burn you. But if you have faith in FB’s long-term future – with a commensurate steely resolve to ride out the swings, big pullbacks in the stock could be opportunities to make you look crazy like a fox.

Tread carefully, and know exactly what you’re buying.

— John Jagerson and Wade Hansen, SlingShot Trader

Article printed from InvestorPlace Media,

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