Beyond the Blame Game: Can Facebook Be Fixed?

The honeymoon is over for Facebook and Mark Zuckerberg. In fact, it ended before it began.

Facebook’s long-awaited and much-hyped IPO is just over a week old, and the blame game is onas the company has lost 16 percent of its value since the initial offering. Wall Street’s take on Facebook has gone from jubilant to jaundiced.

The stock ended its first full day of trading a week ago Friday at US$38.23, essentially flat from its $38 opening price. It did manage to set an IPO record for sheer volume — 567 million shares exchanged hands.

Investors hoped for a turnaround, but it hasn’t materialized. On Monday, a selloff prompted the shares to fall by nearly 11 percent, ending at $34.03. The news worsened Tuesday. The stock sank another 8 percent, trading in the $31-$32 range. By the one-week mark, the picture hadn’t improved. The stock closed Friday at $31.91.

Investors have been quick to assign blame, and they didn’t have far to look. Facebook’s lead banking underwriters, Morgan Stanley (MS), JP Morgan (JPM), and GoldmanSachs (GS) all slashed their Facebook earnings forecasts in the middle of the IPO road show, according to Reuters.

The underwriter analysts cut their estimates after Facebook issued an amended IPO prospectus,in which it used vague language to state that the number of users was growing fasterthan revenue. That was a big red flag. But the worst part of this story is that the sales slippagewas only disclosed to a select few underwriters and not the public-at-large, who were eager tocash in on what they thought would be a great deal.

Industry Calls for SEC to Widen Facebook Probe

The Securities and Exchange Commission (SEC) is already investigating the opening day glitchesthat delayed Facebook being traded on the Nasdaq exchange for about an hour. There are calls for the SEC to widen its probe into why there was not a full disclosureabout Facebook’s lower earnings forecast in advance of the IPO.

The failure to reveal the salesand earnings slowdown helped make Facebook the second largest IPO in U.S. history behindVisa.

Regardless of any actions by the SEC, the takeaway is this: Zuckerberg and Facebook executivesbecame instant millionaires, but the average investor lost because the company wasovervalued.

Can Facebook do anything to reverse its initial slide and avoid a backlash that could cause it tosink even deeper? The company must at least attempt to live up to the hyperbole. As a publiccompany with a very high profile, Facebook is answerable to shareholders and investors.

The slightest fluctuation in the stock price — or worse yet, a continued downward spiral — will beanalyzed and second guessed as witnessed by the headlines and commentary.

It is imperative for Facebook to quickly find ways to accomplish the following:

  • expand its base beyond its current 900-plus million members by attracting new usersinternationally;
  • monetize and productize its services; and
  • build a cogent, compelling and cohesive mobility strategy that includes mobileapplications.

Facebook founder Mark Zuckerberg, who’s firmly in charge with 56 percent ownership, realizes this.That’s why he, his executives and engineers engaged in an all-night “hackathon” at Facebook’sMenlo Park, Calif., headquarters brainstorming ideas to attract new users and coding softwarethat could potentially enrich the company’s coffers.

Investors will be more anxious than ever to see Facebook’s short-term tactical and long-termstrategic plans to grow the company and swell the ranks of the 900 million current users –particularly in international markets.

Established competitors like Google and newcomerslike Pinterest will also be keeping a close eye on Facebook’s fortunes. Facebook must movequickly and decisively to put the billions it made in its IPO to work immediately before the stockdeclines further. Zuckerberg must continue to grow the company, develop new products tosustain and expand profitability, and avoid being a flash-in-the-pan.

Facebook’s Growth Strategies: Organic and by Acquisition

Growth comes from two avenues: organic, in which companies develop their own applicationsand products; and by acquisition, in which they purchase expertise and immediate credibility andan entre into new markets. Facebook must do both.

The global economic climate remains challenging. Many of the top-tier high technology firms,including Google, HP, IBM and Oracle, have made large, high-profile acquisitions. Google, forexample, spent more than $10 billion purchasing nearly 200 firms since its 2004 IPO — plus another $12.5 billion for its acquisition of Motorola, a deal it just closed after receiving regulatory approval in China.

Facebook’s most notable acquisition to date has been the $1 billion purchase of Instagram, whichmakes a mobile photo application.

Fixing Facebook

That’s a start. The type of company Facebook elects to invest in or purchase is equally important.Mobility is unquestionably one of the most lucrative and hotly contested vertical markets. As amobile photo application, Instagram has the potential to appeal to both consumer and corporateusers. And Instagram is also less likely to fall prey to the fickleness that is so pervasive ingaming applications, which typically have the greatest appeal among young users.

Facebook could conceivably ink a deal with a wireless carrier to charge fees to transfer photos and photo albums on mobile phones and tablets. For Facebook to play successfully in the big leagues andchallenge the likes of Google, it will have to make targeted acquisitions in the mobility space thatwill enhance its current offerings to ensure a continuing, solid revenue stream.

Facebook’s most daunting challenge in both the near and long term is how to monetize itsexisting base of users. The obvious answer is to drive greater advertising revenues. One way todo that is to more closely track and sell user information and preferences. However, that strategyis risky and could backfire.

Recently, U.S. automaker General Motors dealt Facebooka blow when it announced it would withdraw its ads from the social media site. According toGM, it did not realize the hoped-for return on investment from new car sales.

This signalsthat corporate giants still view Facebook as largely a social media site geared more towardentertainment and games sales. The company also suffered a recent setback on the consumergames front. CrowdStar, one of its biggest developers, said last month it would stop making newconsumer games for Facebook. Instead, CrowdStar will now focus on creating mobile games.

Facebook’s ads do not yet support mobileadvertising, and its click-through rate is “under 0.05 percent, about half the averageCTR for banner ads across the Internet, thus earning a grade of B+ compared to Google’s A,” according to a recent study from WordStream.

WordStream founder and chief technology officers (CTO) Larry Kim was openly critical ofFacebook’s prospects in an open letter to investors, stating, “So far, Facebook’s advertisingplatform hasn’t kept pace with the explosive growth of its social network, and it remains tobe seen if CEO Mark Zuckerberg even wants to focus on advertising as a source of revenue.”

The study gave Facebook only a “C” grade for targeting ads, noting that it earns “nosignificant revenue” from its mobile applications used by 425 million people on iPhones andAndroids each month.

Facebook must find a way to turn this around. As the majority stakeholder with veto power overminority investors, Zuckerberg must convince Wall Street and the industry-at-large that he andFacebook are more than just a social network aimed primarily at the under 21-crowd.

Severalcritics focused on Zuckerberg’s dressed down appearance and his penchant for wearing a hoodie.The criticisms are not without merit. The late Steve Jobs could proudly sport his “uniform” ofblack turtlenecks and black jeans, but Jobs and Apple had a proven track record of success thatspanned both the consumer and corporate market segments.

If Zuckerberg expects Facebook tobe taken seriously, he’ll have to signal his intentions by targeting a larger and more diversifiedcustomer base.

In another potential setback for Facebook, game maker Zynga’s stock price dropped by 5percent, perhaps impacted by insider selloffs and dwindlingnumbers of users playing the company’s staple online games like “Farmville,” “ZyngaPoker” and “Draw Something.”

There is no doubt that Zynga has been a cash cow for Facebook, which has helped propel its popularity. But the social games market is cyclical, and extremely sensitive to user fads and whims; it is not a reliable source of long-term recurring revenue.

Zynga’s fortunes are subject to sharp reversals. This trend is reinforced by less-experiencedinvestors who panic at the first sign of weakness. If one high-technology bellwether stockperforms badly on a given day, it will create a domino effect, with investors downgrading theentire market sector.

Zynga could just as easily be back on top next week with a new online social game that catches the public’s fancy and helps spur an advertising boom on Facebook, but that’s not something Facebook can count on.

Diversification is another element that’s pivotal for Facebook’s immediate and long-termsuccess. It must have a strong, variegated portfolio of products and partnerships.

Wooing Wall Street and corporate partners, as well as making strategic acquisitions and investmentsin mobile and business applications, must be top priorities for Facebook. The company will also haveto respond satisfactorily to any SEC investigation. Zuckerberg can’t move quickly enough.Otherwise, Facebook could crash and burn faster than the Hindenburg and suffer the blowbackfrom angry users.

Laura DiDio is principal at Information Technology Intelligence Corp. (ITIC), a research and consulting firm that covers the high-tech industry.

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