First and foremost, keep in mind that even if you buy stock, it won’t be your company. You’ll own a minority interest in what the NASDAQ considers as a controlled enterprise. Mark Zuckerberg, will control approximately 57.3% of the voting power of FB’s outstanding capital stock after the IPO. This means Zuckerberg will have total say over the outcome of matters submitted to FB’s stockholders for approval, including the election of FB’s directors, as well as the overall management and direction of the company. Also, as a controlled company, FB’s board need not be made up of a majority of independent directors. Neither will FB be required to have a compensation committee nor a nominating committee, although it could choose one if it wanted. FB’s board, however, has rejected the notion of nominating committee. The full board of directors will nominate new or replacement members to the board.
You might believe there’s no reason to doubt the people who made the company successful in the first place. This, however, offers very little protection for the minority shareholders because Zuckerberg and the board may not be inclined to make decisions that protect the interests of anyone but Zuckerberg and other large shareholders. If the company experiences any downturn, you should realize that Zuckerberg’s interests may diverge from the average shareholder’s interests and be prepared to take action to protect your investment. You should also take care to monitor the company’s operations to see if the rate of return continues to warrant your investment. What Zuckerberg and the Board may find acceptable in terms of a return on shareholder’s equity may be quite different from what you need or expect.
Advertising: Lifeblood of the company
As with many internet sites, Facebook will succeed or fail based on its ability to convince advertisers to pay for space on its site. FB states in the prospectus that since 2008, third party advertising has made up almost completely all its revenue. Given the popularity of FB, and the amount of revenue derived from advertising, it was a bit surprising to see that FB apparently has no bargaining power with advertisers as noted in the following disclosure from the prospectus:
“As is common in the industry, our advertisers typically do not have long-term advertising commitments with us. Many of our advertisers spend only a relatively small portion of their overall advertising budget with us. In addition, advertisers may view some of our products, such as sponsored stories and ads with social context, as experimental and unproven.”
FB has yet to figure out how to convince advertisers that they should consider advertising on FB almost mandatory. Also, FB’s curious decision early on to let advertisers use FB’s free products, such as Facebook Pages, instead of advertising on Facebook leaves it in a bit of a quandary – why should a potential advertiser pay for space when it can simply create its own Page?
Unfortunately, the prospectus does not give us any information on how many advertisers both pay for ads and have their own Pages, nor on how many advertisers, if any, have chosen to use just ads and not a Page. As much as FB wants to focus on providing a unique and content rich experience for folks using the internet, that aim is unattainable as a public company if FB can’t sell enough ads to make a reasonable profit for its shareholders.
The mobility problem
Another thorny problem the company now confronts is the rise in the use of mobile devices to access the internet. In the prospectus, FB states that “Growth in use of Facebook through our mobile products, where our ability to monetize is unproven, as a substitute for use on personal computers may negatively affect our revenue and financial results.” FB estimates it had 488 million monthly average users (a registered Facebook user who uses Facebook in a 30 day period) who used Facebook mobile products in March 2012. Although most of FB’s mobile users also access Facebook through personal computers, FB expects the rate of growth in mobile usage will exceed the growth in usage through personal computers for the foreseeable future.
The problem is that although FB is encouraging mobile users to use Facebook, FB’s practice has been not to show ads to users accessing Facebook through mobile apps or its mobile website. In March 2012, FB began to include sponsored stories in users’ mobile News Feeds. However, FB is not generating any meaningful revenue from the use of Facebook mobile products, and it states its ability to do so successfully is unproven. So investors should keep watch and see if Facebook users increasingly turn to mobile devices to access Facebook and decrease their access to Facebook using computers. Without a way to generate revenue from mobile users, or if it costs too much to target ads to mobile users, it is likely that FB will earn less revenue.
Conclusion
Although there are other issues and risks discussed in the prospectus, this article has addressed 3 of the more important ones. FB seems to have a solid foundation in place in terms of an internet business model where the revenue comes from advertising rather than users of the website. However, the mobility problem, its lack of bargaining power with its advertisers, and Zuckerberg’s controlling interest must all be taken into account before a decision is made to purchase shares of the company.
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