The Future of Facebook

by Vedran Vuk filling in for David Galland

Facebook will certainly be talked about in business books for a long time, but will it be the endless growth story that many predict? With a possible IPO in a few years, I thought to myself, “Opportunity of a lifetime or just another good company.” I’m somewhere in between the two, and hopefully by the time the IPO comes out, I’ll make up my mind.

So, why the hesitation? Millions around the world are absolutely addicted to the social networking website. It seems like a no-brainer. User growth continues to expand. But there’s more to it. While Facebook is one of the hottest sites of the decade, the long-term corporate strategy seems less clear.

To value a company properly, one must know current cash flows and have a good idea of future cash flows. In the case of Facebook, there’s a wide range of possibilities with future cash flows. As the slow decline of social networking website MySpace has shown, the public can be fickle. Could a similar fate befall Facebook?

Another problem that will grow bigger is the privacy issue. Yesterday, the Wall Street Journal revealed a security hole in Facebook linked to independent application programs. Since the story broke, many of the accused applications were shut down by Facebook. Either the company previously knew about the leak and did nothing, or the Facebook team is actually less competent than an investigative journalist. Whichever one it is, this again emphasizes the company’s privacy problems.

Facebook has been generally nonchalant about other security breaches and privacy concerns as well. That comes as no surprise as the CEO, Mark Zuckerberg, has personally made statements showing little respect for privacy. Further, a few company PR statements on privacy matters have even been outright snarky toward concerned users.

While the user base keeps growing, this concern could come back to haunt the company as the primary users grow older and more concerned about the issue. As we’ve written in the CDD and Casey’s Extraordinary Technology, cyber crime is becoming a serious threat. That’s one reason why we suggest investing in cyber security. Currently, much of the population lives in an “ignorance is bliss” world. They have no idea about the vulnerabilities of their identities, bank accounts, and personal information.

And Facebook has been profiting from this blissful ignorance. If you have a social networking account, check how many banking security questions you can find on your friends’ pages. Birthdays, favorite hobbies, hometowns, pet names, favorite movies, singers, email address, etc. Social networking websites are a motivated identity thief’s dream. Eventually, the rest of the world will catch on to the danger. Just as no one leaves their doors unlocked anymore, soon no one will reveal as much info online as now. And that’s going to hurt social networking sites badly.

Another problem could be the growing dissatisfaction with site changes. There’s much grumbling but little action by users in response to changes. Could there eventually be a tipping point with the wrong addition? The company has its own data and should know best. But it makes you wonder about the limits of site changes. Even if the additions are increasing site use, further add-ons and features will likely face diminishing returns soon. How many features and additions can the site possibly have?

Also, there may come a point where the nature of the site changes and growth cannibalizes itself. Once Grandma and Mom start to join Facebook, the appeal may slowly die down. Sure, there are features to block their access, but it’s an extra annoyance.

So here’s the dilemma. On the one hand, the product is amazingly appealing to consumers. They can’t get enough. In fact, Facebook literally spreads itself. On the other hand, management has some long-term strategy issues to address. Growth appears to be driven by the core product – not the recent additions and features. What can the company do to maintain this momentum? Online communities often seem invincible in their peaks, but with poor planning they can suddenly collapse. Who can forget Prodigy or the former heights of AOL or innumerable online games?

With tech companies, investors are always blinded by the vision of Bill Gates and his success after success. But is Mark Zuckerberg a Bill Gates or a Steve Jobs? He’s definitely smart, but I don’t think so. He appears to be riding the wave of this original idea with only incremental improvements. Though the company is doing well, it still might be a one-trick pony. Nonetheless, that’s a very strong and fast pony.

If the company can find a credible long-term strategy to keep users engaged, I would have no hesitations about it. But right now, there are only idealistic phrases and minor site improvements. However, I’d still be interested in purchasing a few shares when the IPO arrives, but I don’t expect Facebook to be the next growth miracle. The company faces real challenges that must be addressed.

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