Even posing the possibility is likely to inspire some 'colorful' criticism, so let me douse that fire before it even starts burning - my intent is only to get investors asking important questions. With that as the backdrop...
Is the Facebook Inc. (NASDAQ:FB) story ultimately going to parallel the classic children's fable "The Emperor is Wearing No Clothes"?
In the original story, a tailor convinces the king that his new garments are the best in all the land, yet will appear to be invisible to any who are not worthy. Of course, the tailor has sewn nothing but a tell tale, but the king falls for the story and begins parading around naked, proud of his new duds. The emperor can't actually see them, of course, but fears acknowledging that because then he too would not be worthy. The people of the kingdom, not wanting to upset the king, all "ooh" and "aah" over the emperor's invisible outfit, though they secretly know the king has been duped. The story ends with a small child - who simply didn't know better than to tell the truth - states "The emperor isn't wearing any clothes."
Now, this isn't to suggest Mark Zuckerberg is walking around naked. It is to suggest, however, that perhaps all of us are too afraid to point out some simple realities about Facebook, for fear of being 'that one ridiculous guy (or gal)' that doesn't think Facebook is all that and a bag of chips.
To be fair, it was a great idea and an outstanding execution. Zuckerberg did with Facebook what a lot of more experienced and deeper-pocketed folks couldn't do with MySpace, which is define social media as an industry. There are nearly 1 billion users now (and will be one billion by August or so), and the number is still growing as the company introduces itself to overseas markets.
The investment value of the company, however, was never really built on profit potential. It was always built on the rapid growth of the user base, and by extension, growth of traffic. What happens when the red-hot traffic and user growth rates start to stall? Suddenly the investment value starts to - or should start to, anyway - be questioned.
And ironically, that's what's happening now, in the shadow of the IPO.
They're admittedly small red flags, but all big problems tend to start as small ones. In no particular order, here are the problems Facebook needs to address sooner rather than later. Otherwise, they may spiral to the point of being unstoppable.
1. User growth is slowing... sort of. Though Facebook has yet to be unveiled to the entire world, in markets where it's been unveiled and had time to proliferate (which is the United States, mostly), a phenomenon has materialized - the user base ends up becoming about half of the market's populous.
Said another way, the user base will eventually plateau, and we may be there sooner than we realize.
Total visits in April of this year were only 5% better than they were a year earlier. That's still growth, but falls well short of the 89% growth rate in visits from a year earlier.
Yes, entering India and China may be game-changers, but those are tough nuts to crack, for several reasons (censorship being one of them). And, there's no guarantee what kind of revenue those markets could drive. The U.S. market only makes up about 158 million of Facebook's 800 million regular visitors, but the U.S. contributes 56% of the company's ad revenue. In fact, the numbers already confirm foreign users are much weaker contributors to overall revenue, on a per-user basis.
That's a dangerous imbalance for those counting on foreign markets to be the game-changer.
2. People are spending less time on Facebook. This is actually a pretty well debated metric, but most of the legitimate evidence is damning. About 35% of its users spend less time on Facebook than they did six months ago, while about 20% of its users say they're spending more time on the site.
Another study said the average number of U.S. Facebook members visiting the site fell 4.8% over the past six months. Presuming the U.S. market has indeed plateaud and even started to contract (and that other market's will do the same) there's clearly an engagement problem.... which is ultimately a threat to revenue.
3. Ad effectiveness was never all that great, and is getting worse. General Motors has dropped their Facebook ad campaign altogether, and many advertisers are coming to the conclusion that the ROI on Facebook ads is too weak to bother with. User comments from friends and others don't bolster ad effectiveness.
Caveat: Though the PC/laptop-based version of Facebook doesn't do all that great at inducing clicks, the mobile version does. Still, there's not a lot of evidence that those clicks turn into revenue for the advertiser.
None of these challenges are insurmountable. But, resolving them may be a much bigger challenge than Facebook's top people may want to admit.
The core of the reason the site because so popular is that the ads were unobtrusive... almost to the point of dismissible (which most users did).
Now, not only does the organization need to better monetize the site within the context of its current technical framework, it will need to retrain its audience to continue using the site but also start doing something most of them have never done.... click. Add in the waning engagement metrics as well as the possibly-peaking active member base to that equation, and what you have is a company that may be wearing no clothes.... even if nobody wants to say it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.