The Economy

Facebook: The Sound of a Bubble Bursting?

The king of social media's IPO flop may signal the end of the enthusiasm for social media as a money-making business.
David RosenbaumMay 30, 2012

In 1999 I was working at CIO magazine and chatting with Amar Goel, a former captain of the Harvard golf team. In 1995 Goel had founded in his dorm room. It was an online business that sold golf equipment and allowed people to buy customized clubs by entering data about their physique and game. The customization piece, Goel told me, was his company’s “differentiator.”

The company had raised about $50 million in venture-capital funding. After brushing aside my thought that people might actually want to swing a club before purchasing one, Goel got down to what he really wanted to talk about: how tremendously cool it was that his Harvard team got to practice at The Country Club in Brookline, Massachusetts, site of the 1988 U.S. Open.

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In 2000, as the dot-com bubble burst, filed for bankruptcy.

To me, Goel seemed less a businessman than he did a golfer.

I was thinking about Goel because another Harvard man, and another company founder, Facebook’s Mark Zuckerberg, has had what some might describe as a difficult few weeks. Yesterday Facebook closed below $29, a loss of 24% since its May 18 initial public offering. On May 18, Zuckerberg was worth $19.4 billion. Today he’s worth $14.7 billion, and no doubt wondering how he’s going to pay his bills. Not only has Facebook pooped instead of popped, as is more typical with IPOs (at least at the start), but its stumble has led some to speculate on its fundamental viability as a business. “If Facebook dies (and it might)” began a headline on CNET today.

To me, Zuckerberg, like Goel, doesn’t seem like a businessperson; he seems more like the hacker he’s proudly proclaimed himself to be. About three weeks ago, I posted a question on a LinkedIn group asking if the fact that the 28-year-old Zuckerberg didn’t dress like a businessman he wore his trademark hooded sweatshirt as he slipped in and out of limousines during Facebook’s pre-IPO road showworried anyone.

Mostly, people said they didn’t care how Zuckerberg dressed. They were more concerned about his business: about whether it was wise that he would retain almost absolute control over the company, and about earnings before interest, taxes, depreciation, and amortization (EBITDA), the absence of which, one respondent pointed out, contributed mightily to the bursting of the dot-com bubble. At the beginning of May, Facebook’s 2011 EBITDA was estimated at $2 billion, meaning that its ultimate IPO $100+ billion valuation involved an historic multiple.

But Zuckerberg’s dress did concern some. Indeed, in the May 28 New Yorker, financial columnist James Surowiecki quoted Wedbush Securities analyst Michael Pachter to the effect that Zuckerberg’s hoodie was a “mark of immaturity” and a way of showing investors that “he doesn’t care that much.”

Not, one might say, businesslike.

But the lack of businesslike thinking, analysis, and processes is characteristic of bubbles. The causes of bubbles have been debated in proportion to their traumatic impact on both individuals and markets. In general, however, it seems they begin when a class of assets is significantly overvalued, or their value is disconnected from some arguably objective measure, such as EBITDA. The dot-coms, famously focused on getting big fast, did not, in general, have much in the way of earnings. As Prof. Mike Cooper of the University of Utah’s Eccles School of Business wrote in a September 2000 article about the dot-com bubble, “A mere association with the Internet seems enough to provide a firm with a large and persistent value increase.”

Today, we’re seeing the same sort of wooly thinking with regard to social media in general, and audience size in particular. Facebook was so highly valued because it has almost a billion members worldwide. That’s gotta be worth something, the thinking goes. There’s gotta be some way to monetize that audience.

Maybe there is. Maybe there isn’t. Right now, there’s no clear answer because there’s another monster looming on the horizon: mobility. According to studies by Cisco Systems, mobile data traffic grew 133% in 2011, and average smart phone use nearly tripled. Cisco predicts that global mobile data traffic will increase at a compound annual growth rate of 78% from 2011 to 2016. Or, to put it another way, by the end of 2012 “the number of mobile devices will exceed the number of people on earth.” (See, it’s not your imagination that everyone you see is clutching some sort of device.)

Facebook makes its money by selling advertising, and selling advertising on mobile devices is extremely difficult (which Facebook itself has admitted as a business risk). This may be why it’s been rumored that Facebook is investigating buying Opera, a Norwegian developer of mobile browsers. It’s also been rumored that Facebook is thinking of getting into the mobile device business itself. If Facebook can become a mobile platform, or an original equipment manufacturer (or partner with one), and not just a place for people to swap stories about themselves, it might indeed become a business. Right now, however, the market seems doubtful. And doubt is the sharp pin that punctures bubbles.