4 Truths about Facebook Risk

by Anthony John Agnello | February 2, 2012 12:31 pm

It’s finally here. Years of rumors, a major motion picture about the company’s founding, 845 million active users, a display advertising business that threatens to top the earnings of the Web’s giants–the Facebook zeitgeist has all been leading to this moment. The social network is making its initial public offering. Filing on Wednesday, Facebook said it is seeking to raise $5 billion, making it the biggest Web-based IPO in history. Hype doesn’t begin to describe the Wall Street chatter. Investors are apoplectic in their anticipation of getting a piece of the Facebook pie.

Which is why now is the time to be cautious. The company’s business is huge and getting bigger by the day, but it would be unwise to forget this unshakable maxim: Consumers are fickle.

As all companies do before going public, Facebook included a list of “risk factors” with its SEC filing, detailing issues that could hurt the company in the future. The company identified 35 of them. These risks don’t lessen the appeal of profiting off of Facebook’s ubiquity, but they do illustrate the fragility of the network’s success. Consider these four truths about the company’s business and the related risks that could hinder its performance.

Every profile is valuable. Every profile may disappear

Facebook raked in $3.71 billion in revenue in 2011. That revenue comes from a variety of places—advertising, games, sales of virtual goods, etc. Broken down across its users, though, a value can be placed on each individual’s Facebook profile. There are 845 million active users, so based on total revenue each profile is worth approximately $4.39. Of course, this highlights the No. 1 risk in Facebook’s IPO filing: People may leave the network. Social network migration has happened before. In fact, much of Facebook’s success followed the swift fall of MySpace. No more users means no more revenue, so Facebook better hope that people stay addicted to updating their profiles.

Zynga is all too important

Never forget the value of FarmVille. That game and Zynga‘s (NASDAQ:ZNGA[1]) other games on the social network generated an impressive $445 million for Facebook in 2011, 12% of the company’s total revenue. That’s why the partnership between the two companies is listed as No. 13 among Facebook’s risk factors. Facebook’s contract with Zynga runs through 2015, but the network is still worried about Zynga’s games migrating to other platforms. That’s just one factor that makes Facebook’s partnership with Zynga a potential vulnerability. It’s also possible that people will lose interest in Zynga’s games. It currently enjoys 200 million users, but Zynga’s popular time wasters are just as vulnerable to changing tastes as is Facebook itself.

Facebook Needs Mobile Advertising Pronto

Most people check Facebook using their phones, not their PCs. About 425 million people, just over half of the entire user base, use Facebook’s mobile version on devices like Apple‘s (NASDAQ:AAPL[2]) iPhone. That’s great for keeping users engaged in the social network, but it’s also a ton of wasted potential. No. 3 on Facebook’s risk list is the fact that its mobile platform doesn’t show ads, which means half of Facebook’s user base is underutilized in generating ad revenue. That’s a problem considering that advertising generated $3.1 billion of the company’s $3.7 billion in revenue last year.

The company’s current growth rate isn’t sustainable

Facebook’s revenue grew 88% last year. Technology companies like Apple have it easy when it comes to sustaining growth. All they need to do is continue making new products and iterating on proven products. Facebook will forever have a more difficult time spurring growth because it can’t introduce a brand new product to entice new users. No. 14 on Facebook’s risk list is the acknowledgment that its growth rate cannot be sustained at such a high rate. That may displease investors down the line. What can Facebook do to maintain growth? Diversify its services. The company’s gone far in branching out, getting into digital movie rentals and other side entertainments to keep users coming back for more. Diversification can keep a Web company alive. Just look at Google (NASDAQ:GOOG[3]). Diversification can also dilute and kill a Web company. Just look at Yahoo (NASDAQ:YHOO[4]).


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