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How To Play The Upcoming Facebook IPO

29 April 2008 6 Comments

Facebook is undoubtedly one of the hottest companies around these days. The rise of the company from a single school online directory to an international network of millions of members of all ages is certainly remarkable. With the company hitting on all cylinders, can we expect the company to move towards an IPO? If so, should the average investor take a position in Facebook?

Why You Can Expect an IPO

Facebook has been and is currently experiencing astounding growth attracting over 100 million unique visitors just this past January. Such high traffic necessitates many servers; these servers are expensive. It is estimated that Facebook will spend $200 million in capital expenditures in 2008 upgrading their systems to handle current and future growth.

Despite the incredible traffic that Facebook continues to generate, the company is still in the process of determining just how to translate all the online traffic into actual dollars; 2007 revenue is reported to be $150 million. Although Facebook collected $300 million from Microsoft (MSFT) recently, they will need additional funding. An IPO is most likely the route they will take to acquire additional funding.

Another factor is the 1934 Securities Exchange Act which says a company that has over 500 shareholders and above $10 million in assets must report as if the company were a publicly listed company. If we assume most, or all, of Facebook’s employees have stock options (which is what most technology companies use to recruit talent), then this provision could be applicable to Facebook very soon. Similar to Google’s pre-IPO days, this provision could fuel the momentum pushing the company towards an IPO.

Facebook’s Long Term Flaw

Now that we have made a strong case that a Facebook IPO will most likely occur, and occur soon, the question is: Should you invest in Facebook when they become public? While there will most likely be enormous hype and possibly an initial surge in stock price following the IPO, I believe there is minimal long term potential.

In the current social networking landscape, the two largest players, Facebook and Myspace, are focused more on competing against one another than on the future of social networking. Facebook is doing their best to dominate social networking and to have the largest number of members within the Facebook umbrella. The problem is that social networking is a concept too big for a single company or even a handful of companies to own. The trend towards a single, open network is picking up momentum and unfortunately for Facebook and others, I think it is a trend that will overtake any companies, such as Facebook, that do not embrace the trend. Let me explain further…

The Future of Social Networking

First, let us define “social network.” Simply put, a social network is the mapping of everybody and how they are related. On Facebook, you are related to others through friendships, events, groups, etc. The problem is, what if you wanted to connect with your friend who is a Myspace member. That person would either have to register on Facebook and re-declare all of his or her friends, or you would have to do the same on Myspace. These social networks are “closed” from eachother. The current social networking environment consists of multiple closed social networks as the following diagram shows:

Wouldn’t it make sense to have a single, comprehensive, decentralized social network where you could connect with anyone else that is tapped into the global social network? There are companies and individuals out there that are already putting pieces into place to make this happen. Google is one company leading the charge in this arena.

The future is the blending of the concept of the entire internet with the concept of the social network. Single companies like Facebook are not and do not control the social network. The social network simply exists. Companies will alter their focus from the current one of building social networks to that of building applications that tap into the global social network. The below diagram illustrates this concept.

Facebook through its developer platform (Myspace and others have similar platforms now also) has enabled growth of applications to use the Facebook social network, but these applications are limited to only the Facebook network. Again, the social network is too large for one company to own it.

Facebook’s Future

While Facebook is an incredible company and they have been instrumental in creating the social networking mania that exists today, unless they alter their strategy and open their users to a large scale social network, I believe their future is bleak. Zuckerberg should sell Facebook now while the hype is at its peak. Those entities that are willing to overpay for a chunk of Facebook, like Microsoft, stand to lose the most.

It is my hope Facebook that gets behind the open social network concept and helps drive it forward; however, their strategy (as well as Myspace and others) seems to be to “own” as many members as possible. It is highly unlikely that they will decide to change their strategy and simply “let go of their users.”

In the future, it won’t be enough to simply be a social network. It would be like a company trying to be an exclusive internet and compete with the worldwide network that is the actual internet. Doesn’t make sense, does it?

Sit Back and Watch The Excitement

I believe social networking is, in fact, one of the most transformative communication concepts in recent history. The concept itself has truly changed human behavior and interaction which is incredibly powerful. Facebook has been crucial to the growth of such an transformative concept; however, they have helped birth something so revolutionary that it may be their downfall to attempt to control it.

As the company moves towards more growth and possibly an IPO, there will be tremendous hype surrounding Facebook. There may be some short term plays during the excitement period immediately following a Facebook IPO; however, I do not think that this company, based on their current strategy, is a solid long term investment. It will be an exciting IPO and fun to watch, but my advice for most investors it to do just that: watch.

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  • dave said:

    Is this the same argument that some say is undermining all proprietary software and applauding Open Source as the future?

  • kevin duffey said:

    It’s a different argument. This is more about a movement as opposed to a single piece of software. Social networking is something too big to be constrained to companies “owning” the networks themselves.

    With regards to software, open source software is huge, but at the same time, proprietary software is still doing great. Look at Apple’s software, OS X, etc.