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12 May, 2012 10:48

Facebook – to invest, or not to invest?

Facebook – to invest, or not to invest?

As Facebook’s $11.8 billion IPO approaches with too many investors eyeing up more shares than are available, experts are concerned that the internet’s largest offering to date could create another bubble, soon to burst.

So, what are the pros for an investment in Facebook?

Facebook has grown the number of users at a breathtaking pace over the past few years. The latest count was 901 million at the end of Q1-2012. Growth in users opens up a lot of opportunities for Facebook to create business and, therefore, revenue. Via its “engine”, Facebook is able to construct a fairly precise image of its users – what they like, their habits. This is very valuable, as marketing on the internet can sometimes be somewhat risky. How does the owner of a site “document” the effect of a dollar spent if users just pass by as an unknown Joe? The more an owner, in this case Facebook can show a fit between audience and marketer, the larger the bang for the buck. This will increase the revenue for Facebook and at the same time attract more ads.Users have built their connections over several years, which also represents an asset. To change this becomes cumbersome, so users don’t leave their well-established network.Games embedded in Facebook keep users logged in, representing a higher value for the company, and generate revenue:  take for example the collaboration with Zynga. Facebook’s dominant role means it is capable of calling the shots. Users and businesses have less room to contest the decisions the company takes: it is more or less take it or leave it – Facebook has the upper hand and bargaining power.

Now, the reasons to stay away

Facebook shares look like an attractive investment, but let’s look beyond the hype.  The higher the valuation (+$100bn), the more money people are willing to invest. But even if Facebook does develop at an amazing pace over the coming years, you as investor are not guaranteed a big return on your buck. You paid for it at the IPO. The first test of whether the value holds will come during the first year, where each earnings report will be an acid test.Social media and business is actually a difficult construct. There are unwritten rules on how to engage and act, both with user-to-user, and social site to user.Taking the latter – it costs money to develop and host a site, so a revenue stream is necessary and users are aware of this. But users don't like feeling too “targeted” as prey for revenue. The more a site extracts revenue while annoying users, the higher the risk of users migrating to other opportunities. When do you step over this invisible line?In the case of Facebook, it would be devastating if other sites suddenly became flavor-of-the-moment, pushing millions of users to change sites. This could over time create a tsunami, crumbling the existing business model. Users can be fickle and investors should have this in mind.Just take a look at why MySpace, the former number one social media place to be, lost big time to – yes – Facebook. It was too aggressive in several areas and went ways the community was not prepared to go. Well Facebook might be huge, but Goliath was defeated once. It can happen again.The business prospects in social media might therefore be less rosy, as CEO Mark Zuckerberg will have to develop Facebook with a larger safety margin to make sure not to alienate users. One or two missteps can change the whole future for Facebook, and this could happen over a short time period. The profit opportunities could therefore be less that we all think.

Peter Bo Kiaer, Equity Analyst at Saxo Bank, is an author of the above article.Disclaimer: The views and opinions expressed in the story are solely those of the author and do not necessarily represent those of RT.