Great expectations from Facebook

Technology companies, when they make their market debut, always seem to flout traditional notions and metrics of valuation. Social networking site Facebook, which expects to raise $5 billion through an IPO, valuing the company at a price tag of $75-100 billion, is therefore just the latest instance. If one adopts the popular valuation metric of price-earnings ratio, that price requires investors to pay $75-100 for every dollar of Facebook's current earnings.

However, private investors in Facebook have been willing to pay a similar price for a share of the action on the social networking site. As a result, its market value has grown more rapidly than its user base in the last three years. The company's user base grew from 150 million users in early-2009 to 845 million users in 2012. But in private trades, this company's valuation has soared from $6 billion in early-2009 to about $100 billion in recent trades.

The firm has attracted a long line of investors from pension funds to private equity players, to marquee investment banks and their high networth clients. Given that Facebook has had little trouble raising funds privately, the public listing is expected to serve as an exit option for these investors.

So what is Facebook's proposition to investors? Advertising, as is the case with most Internet-based businesses. What Facebook hopes to do, is to track the behaviour of its vast community of users to help draw advertisers to their most relevant users.

A hypothetical post such as “Ran outta toothpaste today..” could spark Facebook's servers to bomb you with ads from Pepsodent or Colgate. Facebook could do this with computers, cars, pubs, restaurants and everything under the sun! The comment could also spark a visual, with Shah Rukh Khan inviting you to a divine brushing experience with Pepsodent. Advertisers have long loved the engaging experience ‘display advertising' provides and shell out a premium for this. Facebook has the largest market share in the US in this lucrative advertising space. According to eMarketer, the US display market grew at a rapid clip of over 20 per cent in 2011. Facebook managed to bag 27 per cent of the entire market, comfortably topping peers in the segment. eMarketer expects the company to sustain high levels of growth in this segment.

THE ZUCKERBERG CONUNDRUM

But the assumption that Facebook users will respond to the display ads and lap up the advertised products or services can be questioned. If your ‘Facebook friend' likes Close-up toothpaste following a fruitful date, that could be among the top posts on your wall. But would this influence you to buy Close-up? And would users immersed in chatting and sharing information be sufficiently inclined to click on a jarring ad?

Even if users were to click on all these ads disguised as posts, the question is if they will act on the advertising message to, say, buy Close-up the next time they are in the store.

Users could also take objection to Facebook's initiatives to monetise the treasure troves of personal information that is shared on Facebook. Increased investor scrutiny and earnings pressure could drive Facebook to share more data with advertisers and application developers. This would be pivotal in the company growing and competing better.

But, users might not be too comfortable with the idea of their data being available more openly or to more people than it already is. If Facebook settles on an interface where users need to click on ads more than they do now, it could drive them to a less demanding platform.

Apart from monetising its current user base, Facebook is also looking to expand into new markets to keep its user numbers growing.

Two big growth drivers for the company are emerging markets and mobile phones. Re-entering China could possibly rank among the company highest priorities. But as with most Middle-Kingdom ventures, Facebook could wind up engaging more with the government than with its own users. Well-entrenched and more culturally attuned Chinese sites are likely to give Facebook a good run for its money (unless Facebook winds up buying one of them) too.

Zuckerberg and co. face difficulties in Europe and back home where privacy watchdogs are breathing down their neck. As a dominant player in the social-media space, the slightest hint of an aggrieved smaller social site could have regulators aiming their anti-monopoly guns at Facebook.

MOBILE WARS

The growing smartphone market, too, represents a big yet tricky opportunity. The two dominant mobile platforms now are Apple's iOS and Google's Android. Text-based ads are Google's largest revenue stream. The company is making in-roads in the mobile display and text-ad space with its mobile search and Android platform. Apple is also exploring the display advertising market to increase revenue from their iOS platform. How would these two companies respond to Facebook bombarding app-users with advertising?

With mobile screens far smaller than traditional computer screens, advertisements popping up and occupying half the available screen could prove to be a major annoyance to the user. Relevance and aesthetics will be the key challenges which will call for sharpened algorithms and prettier interfaces. Both are very familiar territory for Google and Apple respectively.

A NEW GIANT

Weighed against this though, Facebook already has the momentum going for it. For one, it costs next to nothing for Facebook to add an additional user. As for the user, it currently costs nothing to sign up. It would help that most of their friends are on it. Facebook has connected close to a third of the estimated global Internet users. The remaining 1.5 billion are unlikely to be as lucrative as the 845 million who already signed on.

Getting in early with this crowd will give Facebook a chance to make itself part of the nascent online-ad market much like Google has done over the last decade. The social networks' ace is that with every added week spent by a user on Facebook, it gets that much more addictive and consequently more difficult to migrate from the platform.

Growth in terms of new sign-ups will get harder as evidenced in recent months. But Facebook still remains the largest play on the social media space and the associated potential of advertising revenues that comes with it.

Adding more users in new markets, getting them to click on the ads and begin to transact on the site, will therefore hold the key to whether Facebook can generate the scorching growth demanded by its IPO valuation. That's the game Zuckerberg and co. needs to get on top of to make sure that its initial investors remain its friends.

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