Tuesday, May 29, 2012

It's all in the S-1

Washington, D.C. 20549

Form S-1
The Securities Act of 1933

Facebook, Inc.
(Exact name of Registrant as specified in its charter)

Form S-1 is the registration form an IPO has to file with the Securities and Exchange Commission (SEC).   In that form, a company has to list "risk factors". Few people bother to read these forms, before investing.

The following is an excerpt from Facebook's form S-1.   Note that they are no longer claiming a Billion active users, or even 900 Million active users, but 845 Million active users - which I presume includes me - and I no longer use the site, although I have yet to close my account.

Note that while a lot of the risk factors are "what if" scenarios (which are rapidly becoming "what is" scenarios), the preamble mentions risk factors that are inevitable - namely that as the user base grows, the increase in growth rate will stagnate.  (I have underlined this portion).  This is a predictable mathematical scenario, as you cannot increase your growth rate indefinitely.  Like any pyramid scheme, it eventually unwinds.

Facebook may settle down to a much smaller, but still-profitable company, with a reasonable stock price and P/E ratio, much as other IPO companies have done.   At $6 a share, it would be rationally priced.   At $30 a share (today's opening price) it would have to increase profits by a factor of five to six.

Anyway, the following is an interesting piece of reading, in retrospect:

Risks Related to Our Business and Industry

If we fail to retain existing users or add new users, or if our users decrease their level of engagement with Facebook, our revenue, financial results, and business may be significantly harmed.

The size of our user base and our users’ level of engagement are critical to our success. We had 845 million monthly active users (MAUs) as of December 31, 2011. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users. We anticipate that our active user growth rate will decline over time as the size of our active user base increases, and as we achieve higher market penetration rates. To the extent our active user growth rate slows, our business performance will become increasingly dependent on our ability to increase levels of user engagement in current and new markets. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. A decrease in user retention, growth, or engagement could render Facebook less attractive to developers and advertisers, which may have a material and adverse impact on our revenue, business, financial condition, and results of operations. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if:

users increasingly engage with competing products;

we fail to introduce new and improved products or if we introduce new products or services that are not favorably received;

we are unable to successfully balance our efforts to provide a compelling user experience with the decisions we make with respect to the frequency, prominence, and size of ads and other commercial content that we display;

we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance;

there are changes in user sentiment about the quality or usefulness of our products or concerns related to privacy and sharing, safety, security, or other factors;

we are unable to manage and prioritize information to ensure users are presented with content that is interesting, useful, and relevant to them;

there are adverse changes in our products that are mandated by legislation, regulatory authorities, or litigation, including settlements or consent decrees;

technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience;

we adopt policies or procedures related to areas such as sharing or user data that are perceived negatively by our users or the general public;

we fail to provide adequate customer service to users, developers, or advertisers;

we, our Platform developers, or other companies in our industry are the subject of adverse media reports or other negative publicity; or

our current or future products, such as the Facebook Platform, reduce user activity on Facebook by making it easier for our users to interact and share on third-party websites.

If we are unable to maintain and increase our user base and user engagement, our revenue, financial results, and future growth potential may be adversely affected.

We generate a substantial majority of our revenue from advertising. The loss of advertisers, or reduction in spending by advertisers with Facebook, could seriously harm our business.

The substantial majority of our revenue is currently generated from third parties advertising on Facebook. In 2009, 2010, and 2011, advertising accounted for 98%, 95%, and 85%, respectively, of our revenue. 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. Advertisers will not continue to do business with us, or they will reduce the prices they are willing to pay to advertise with us, if we do not deliver ads and other commercial content in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. Our advertising revenue could be adversely affected by a number of other factors, including:

decreases in user engagement, including time spent on Facebook;

increased user access to and engagement with Facebook through our mobile products, where we do not currently directly generate meaningful revenue, particularly to the extent that mobile engagement is substituted for engagement with Facebook on personal computers where we monetize usage by displaying ads and other commercial content;

product changes or inventory management decisions we may make that reduce the size, frequency, or relative prominence of ads and other commercial content displayed on Facebook;

our inability to improve our analytics and measurement solutions that demonstrate the value of our ads and other commercial content;

decisions by advertisers to use our free products, such as Facebook Pages, instead of advertising on Facebook;

loss of advertising market share to our competitors;

adverse legal developments relating to advertising, including legislative and regulatory developments and developments in litigation;

adverse media reports or other negative publicity involving us, our Platform developers, or other companies in our industry;

our inability to create new products that sustain or increase the value of our ads and other commercial content;

the degree to which users opt out of social ads or otherwise limit the potential audience of commercial content;

changes in the way online advertising is priced;

the impact of new technologies that could block or obscure the display of our ads and other commercial content; and

the impact of macroeconomic conditions and conditions in the advertising industry in general.

The occurrence of any of these or other factors could result in a reduction in demand for our ads and other commercial content, which may reduce the prices we receive for our ads and other commercial content, or cause advertisers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results.