Three months ago, it was the most high-profile initial public offering in U.S. history. Today, it's just another over-valued, under-performing stock – the latest in a lengthening line of social media companies that hit the market with much fanfare but went on to show little growth.
Facebook Inc. reports quarterly earnings for the first time as a public company on Thursday. Analysts are expecting somewhere in the range of $1.1-billion (U.S.) in revenue and 12 cents per share in profit. Given the social network's massive valuation, Facebook will be under significant pressure to meet the estimates.
But as far as omens go, this hasn't been a good week for Mark Zuckerberg's company. Besides advertising, Facebook makes the biggest portion of its money from a cut of the myriad social games that run on the site – and in that category, the company Zynga is Facebook's biggest and most lucrative partner.
On Wednesday, however, Zynga produced a dud of an earnings report, posting weaker-than-expected second-quarter results and miserable forecasts for the rest of the year. Since Facebook gets a 30 per cent cut every time somebody buys a virtual plough on Farmville (disclaimer: the author has never played Farmville, and can only assume purchasable ploughs are available), terrible Zynga earnings are a bad sign for Facebook investors.
Diversification is going to be a pretty important keyword for Facebook investors in the coming years. Zynga was responsible for a whopping 12 per cent of Facebook's revenue last year – a risky situation for the social network, given that Zynga's own viability depends on users' continued interest in amassing digital farmland and playing other casual games. (An example of just how fickle users can be when it comes to social games: Earlier this year, Zynga paid $180-million for the company behind Draw Something, a social game that was a massive success just a few months ago. Today, Draw Something has a tiny fraction of the daily users it had in the spring, and shows no signs of a rebound. Users, it seems, have moved on to the next thing).
Investors will also want to see signs of expansion. Facebook's user growth rate has dropped considerably in recent months – but that's mostly because there are only so many people on Earth who use the Internet, and more than 900-million of them already use the social network. In some countries, such as Turkey, the vast majority of Web users already have Facebook accounts. In other countries – most notably, China – Facebook has yet to establish anything resembling that kind of dominance.
But cracking such markets can be difficult, and not only because of regulatory and political hurdles. Social networks tend to lend themselves to a kind of snowball effect – people join the network because their friends are on the same network, and so on. A prime example of this phenomenon is Orkut, the Google-owned social network that enjoys huge popularity in Brazil, India, Estonia and pretty much nowhere else. In China, a number of social networks and messaging services, including QQ and Renren, have already gained a sort of critical mass that makes it very difficult for Facebook to catch up.
But hundreds of millions of users aren't any good to investors if Facebook can't figure out how to generate revenue from them. Most of the social network's new users are accessing the site from their mobile devices, and Facebook has already admitted in regulatory filings that it has no real idea how to make money off mobile ads. Additionally, some large advertisers – such as General Motors Co. – have publicly questioned the effectiveness of Facebook ads.
In theory, Facebook ads should be effective because the site knows so much about its users, and can allow advertisers to hone in on very specific demographics. In reality, however, Facebook's advertising algorithm today tends to do little more than offer up wedding dress ads to users who recently changed their relationship status to "Engaged."
But in that respect, Facebook is caught between a rock and a hard place. If it can't offer its clients a demonstrably effective advertising platform, those advertisers will spend their money elsewhere. But if it exploits its massive store of user data too aggressively in order to placate advertisers, it risks outraging privacy advocates.
If you bought Facebook shares on the day of their debut in May – when a phalanx of big banks had to gobble up millions of shares just to keep the stock from dropping below its opening price of $38 – you're currently down about $9 per share. That's not a stellar first three months, especially for a company that hit the market in an unprecedented frenzy of media attention and general hype.
It's pretty clear Mr. Zuckerberg never really wanted to take Facebook public. But SEC regulations – which essentially begin treating a company as public after it reaches a certain number of private investors – forced his hand. But regardless of what happens to Facebook's share price, Mr. Zuckerberg remains the controlling shareholder, CEO and chair of the board, able to do pretty much whatever he pleases. Investors who buy Facebook shares on the NASDAQ are, at best, just going along for the ride.
Still, Facebook's share price matters. It is the first and most prominent number for anyone looking to see how much faith the market has in the world's most popular social network. And if Facebook disappoints on its very first earnings report, that number is going to plummet.