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Saturday, Feb. 11, 2012

Facebook moves from the virtual world to the real one


Special to The Japan Times

HONG KONG — Mark Zuckerberg has come a long way in eight years: The erstwhile spotty Harvard dropout built a dream called Facebook, which will turn him into the fourth richest person in the world, worth about $28 billion when Facebook goes public in the next few weeks

The flotation raises important questions not only about the genius of one ambitious young man but about the use of their time by the growing generation in the West, the priorities of the financial markets, the operations of the Internet and indeed the direction of capitalism in the West. Most commentaries so far have been mesmerized by Facebook's numbers that they have not paused to ask these seminal questions going to the philosophical heart of the modern world of finance, business and capitalism

Some of the numbers are breathtaking. Facebook (still not recognized by the Microsoft Word spell-checker as a legitimate word) has more than 845 million users, and expects to reach a billion this year. As The Economist noted, if Facebook were a country, it would be the world's third largest in terms of population. Unlike other companies at the time of the Internet bubble, Facebook has revenues, $3.7 billion last year, and healthy profits of $1 billion, amazing in just eight years.

Facebook users upload 250 million photographs a day, click that they "like" items posted by friends 2.7 billion times a day and have a web of 100 billion friends and connections on the site. Last year 56 percent of Facebook's revenue came from advertising. Its profit margin is 27 percent, just above that of Google, and way above the 5 to 10 percent of most physical businesses

A valuation on the low side, say $85 billion, for Facebook would be nearly 25 times last year's revenues and 85 times last year's profits. Facebook is expected to be more than five times more expensive than Google's IPO and almost 40 times more expensive than the average large IPO of the last 40 years. The historical average price-to-earnings ratio of the Standard & Poor's 500 is 16.5 to one, and the price-to-sales ratio is about 2.5 to one, both extremely modest by Facebook's trajectory.

Can investment bankers be serious in going along with this pricing or are they just greedy for their share?

Given these multiples, most of the analysts and critics on the balding, graying and wrinkly side of 50 have been skeptical about Facebook's IPO. In spite of the public filings there are big unanswered questions, apart from the price of the shares, privacy and when the original investors will cash in their shares. There are issues as to whether Facebook has reached its peak in terms of users, given that China is virtually closed, and Japan and South Korea have their own favored social networks. There is the vital question whether Facebook can squeeze more profits per user, given that it has listed little expertise or experts other than Zuckerberg and his chief operating officer Sheryl Sandberg

For potential investors — if you can get hold of a piece of the action — the lesson of Google is that if you got in at the opening price of $85 and held on through difficult times, you made an annual average return of 40 percent; but if you bought in a rising market, you would have done better with Treasuries. Yahoo, trading on a price-to-earnings ratio of 125 at one time and today at 19, is a different story, as is Apple, which rode a roller-coaster almost to hell and back. In these days when shares are churned and change hands every 22 seconds, the stock market is not a place for widows and orphans

Zuckerberg, who will keep 53 percent of Facebook's voting rights, thanks to a dual share structure, is highly ambitious. As part of the paperwork for the IPO he presented a personal letter, ranging in tone from merely missionary to positively messianic. He begins: "Facebook was not originally created to be a company. It was built to accomplish a social mission — to make the world more open and connected." He goes on for more than five pages in similar vein, hoping to "get everyone in the world connected, to give everyone a voice and to help transform society ... to change how people relate to their governments. ..."

Such sophomoric zeal strengthens the doubts about whether Facebook can survive in an adult world. James Kwak of "The Baseline Scenario" questioned whether people would want to allow their shopping choices to be dictated by advertisers willing to spend the most money for their attention. Facebook's supporters retort that the site's capacity to tailor advertising to its users based on their particular likes is a source of its greatest strength. Similarly, a big challenge is the growing use of mobile telephones rather than computers to access the site, so Facebook must discover ways of promoting ads on the mobiles.

The Economist, in a lengthy highly positive commentary said that Facebook could create its own advertising network using its tentacles already spread across the Internet. It could also attack the online-search business, accounting for nearly half of online advertising in the United States. Another potentially profitable area is to promote Facebook Credits, a virtual currency, for which the company will accept payment in more than 40 actual currencies, including the euro and the Vietnamese dong, with exchange rates adjusted daily. Credits currently account for about 10 percent of Facebook business, but could become a mainstay for real world payment of mainstream items

One key question is whether Facebook is a virtual or becomes a real force in people's lives. Supporters say that with a billion dedicated users, some of whom spend six to eight hours a day on the site, a $100 billion valuation assumes that each user contributes only $100, surely an underestimation of the potential earning power given the dedication and the details that Facebook knows about each user's life and likes and dislikes. But by the same token Facebook today making $4.38 per user, is failing to live up to its potential.

At some point too, users may complain that it is their information that is enriching Zuckerberg. This leads to a question that baffles the wrinkly skeptics: Can Facebook be regarded as serious? Surely sooner or later those who are hooked will come to their senses and realize that spending six to eight hours a day sending photographs and clicking "like" to the rest of the world does not make for a constructive day or contribute to GDP or even to greater personal happiness

There is also a wider issue involving privacy and freedom. Tim Berners-Lee, the inventor of the World Wide Web, criticized Facebook — surely correctly — for being a "walled garden" because it takes information and keeps it exclusively, thus damaging and fragmenting the Internet.

Critics contend that Facebook is rather like the Hotel California in the Eagles' song, where you can check out anytime but never leave. An increasingly important question is likely to be who owns the information about yourself that you put on your Facebook page. Whether used well or used badly, such virtual information becomes real power, and probably the key to Facebook's future.

Kevin Rafferty, not a Facebook user, is editor in chief of PlainWords Media.


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