Facebook, like Instagram, has generated their absurd 'value' solely from their potential - not from their income revenue streams or profit margins. Therein lies the problem - the value of the company is not based on its $1.5 billion operating profit in 2011, but rather how many users are on the site.
We dug up an interesting conversation over at Forbes.com from February this year, where the following meme was published:
What this creates is an alarming game of pass-the-parcel, which is pretty much a mirror-image of the last time everyone thought they were going to make millions off the internet without having any "real" money. In the late 1990's, upstart internet companies were given ridiculously high values based on their potential in the new digital age. Of course, as none of them were making any money, once investors stopped pouring millions of dollars in, they simply ceased to operate and the money invested had been turned into stock shares of companies that no longer operated (ie. worthless).
The writing has been on the wall ever since - internet-based companies come with a massive risk of not having "real" money, only "value." In a traditional business sense, a company that took some eight years to turnover it's first profit with the audience Facebook has (all while being a market leader for at least half of that time) would raise some alarm bells.
We'll get even nerdier after the jump...
Facebook was developed and has largely been run solely on funds from outside investors. These investors 'buy-in' to Facebook with what is effectively a donation to the business in exchange for company stock. When Facebook sells it's shares at $38 each, these investors who were given a million shares five years ago for their investment are all of a sudden millions and millions richer (assuming they sell. If they hold on to them, it is nothing more than "value" they are holding on to, not "money." There is an important difference.)
But, as with all major market crashes (any stock market crash, the housing bubble in the US following the sub-prime mortgage crisis, etc) the music has to stop with the 'parcel' in some unlucky investors' hands. In the case of a housing crash, the music stops when the current owners take out a $200,000 mortgage to buy a property that plummets in value to $100,000 twelve months later (the previous owner having made their "real" money when they sold; the current owner having lost their "value" in the proeprty when the market crashed). In this case, it won't be Zuckerburg, or any of the initial investors, or any of the Facebook staff who have become overnight millionaires with their stock share who will be stuck with worthless shares they paid a premium price for (again, assuming the stock holders sell at least some of their stock).
What may eventually happen is, one day, the dime will drop that Facebook isn't worth the billions that has been invested in it. Anyone with a $38 share of Facebook today, might be holding onto a $19 Facebook share in a few months.
If 100 million people delete their Facebook accounts tomorrow, that value will drop dramatically. Yes, Facebook made $1.5 billion in profits in 2011. If they don't make that much next year, or the year after, or the year after that, the value of the company could plummet.
And that's exactly the risk of internet-based companies - just take a look at MySpace.
This isn't to say Facebook won't be a successful investment in the long run, and it is more than fair to say there are stark differences between MySpace and Facebook, which has proven far more successful at maintaining an audience.
But the pressures on the company will now be to retain the users - the value - of the site, and anyone with a piece of the Facebook pie will want more users, and more value for their investment. It's a minefield for financial disaster as we still haven't worked out just why Facebook is so popular.
The important thing to take away here is the concept of "value" vs. "money." There is a massive difference, and investors need to be careful not to confuse the two if they want more "money" in the long run.
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