What Is Facebook Afraid Of?
I don't know if you heard, but Facebook finally kicked off the regulatory process of going public. Amid the financial data and business plans the company filed in an S-1 report Wednesday night, you'll also find a list of risk factors. These are the roadblocks and speed bumps that could derail Facebook's gravy train, rip the guts out of your personal investment, or both.
Risk-factor lists in SEC filings don't have to be presented in any particular order, but the discussion must be "organized logically," and many companies rank them by threat level anyway. That goes with the "plain English" requirements of these presentations, and it's also plain good manners toward your current and prospective shareholders. Looking at Facebook's list, I believe that the social network's lawyers and PR people stuck with that principle, so I'm assuming the risks are ordered from the biggest danger to the smallest.
In the filing, Facebook lists 38 business risks and 12 additional hazards for owners of the stock. Nobody ever got sued for listing too many business risks, but the sheer bulk forces me to pick a few cherries. So here we go.
Risk No. 1: We need users
"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."
It doesn't take a genius to figure out that Facebook needs lots and lots of users to keep the gravy train a-rolling, or that they need to be motivated to keep using the service. Without ad-clicking customers, Facebook is nothing. In this regard, Facebook is no different from Google (NAS: GOOG) or Yahoo! (NAS: YHOO) , which also depend on ad clicks for their very lifeblood.
This one absolutely belongs at the top of the list.
Risk No. 2: We need advertisers
"We generate a substantial majority of our revenue from advertising. The loss of advertisers, or a reduction in spending by advertisers with Facebook, could seriously harm our business."
That's the flipside of the same advertising coin. Tons of customers don't help a lick if the ad feeds are empty. Moving on.
Risk No. 3: Mobile users hurt
"Growth in use of Facebook through our mobile products, where we do not currently display ads, as a substitute for use on personal computers may negatively affect our revenue and financial results."
This one might be a shocker. Smartphones and tablets just don't feel complete without a Facebook app, right? But the explosive growth in mobile computing isn't all wine and roses for Facebook, because the apps don't come with company-backed ad feeds. Until Zuckerberg figures out how to monetize mobile platforms, this trend will be a drag on financial results.
Risk No. 4: We don't own iOS, Android, or HTML standards
"Facebook user growth and engagement on mobile devices depend upon effective operation with mobile operating systems, networks, and standards that we do not control."
This business rests squarely on technologies that other companies and non-profit organizations control. The filing further bemoans, "There is no guarantee that popular mobile devices will continue to feature Facebook," giving Google and Apple (NAS: AAPL) the power to change their standards and kill mobile Facebook apps at any given time. Likewise, Facebook can't promise that HTML, Flash, or any of the other technologies underfoot will be there forever. Maybe the next hotshot standard just won't work with Facebook.
I wouldn't lose any sleep over that possibility, though -- at least not until one of the other threats kills the company. New Web or mobile standards that just won't work with one of the world's most popular online services don't make any sense.
Risk No. 11: We might move too fast sometimes
"Our culture emphasizes rapid innovation and prioritizes user engagement over short-term financial results."
In even plainer English, Facebook might disappoint investors because the financial results are not as important as the hunt for more users. This one pairs up with Factor 29: "We cannot assure you that we will effectively manage our growth."
Stretch that risk out a bit further, and it's easy to imagine one small miss cascading into bigger and bigger flubs, made worse by bigger impacts for one quarter to the next. Before you know it, the balance sheet is empty and there are still bills to pay.
Digital-video pioneer Netflix (NAS: NFLX) often catches flak along these lines. That company is also chasing new customers with every weapon in its arsenal, but the subscriber counts stands at the tens of millions instead of Facebook's hundreds of millions. It's just harder to get a billion customers when they have to pay for a subscription. But the principle is the same, so if you hate Netflix for running after users like a lecher on his first Vegas vacation, you'll hate owning Facebook as well.
Risk No. 22: Mark Zuckerberg will always be the boss
"Our CEO has control over key decision making as a result of his control of a majority of our voting stock."
That's putting it modestly. Through a complicated web of investor agreements and very interesting bylaws, Zuckerberg controls about 57% of the voting power in Facebook. His megavoting Class B shares are very unlikely to ever be diluted below the 50% mark, and he even gets to choose who grabs that voting power after his own death.
That's absolute, dictatorial power to the Nth degree. This risk statement helpfully explains how this might affect investors: "As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as a result of voting agreements, in his own interests, which may not always be in the interests of our stockholders generally."
Make sure you trust this guy before you invest in his company, in other words. I don't know Zuckerberg personally, but handing this level of unconditional trust to anyone less than Warren Buffett makes me queasy. This item easily belongs in the top 5, not way down in the 20s.
In fact, that absolute control is a deal-breaker for me. Zuckerberg reluctantly agrees to share his favorite toy with investors, but we have no say in how the company is run. Even activist investors with billions of dollars in capital assets don't stand a chance at making a difference. Carl Icahn can safely unfriend this company, because his money is no good here.
So if Facebook runs too far and too fast, as we've been warned that it might, the checks and balances that could prevent it from becoming the next MySpace or Friendster sob story just aren't there. It all comes down to one person with enough of an ego to place all these safeguards around his power. And that super-sized ego could very well lead Facebook down some very dark alleys.
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At the time this article was published Fool contributorAnders Bylundowns shares of Google and Netflix but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Apple, Google, and Yahoo!Motley Fool newsletter serviceshave recommended buying shares of Netflix, Adobe Systems, Yahoo!, Google, and Apple, creating a diagonal call position in Adobe Systems, and creating a bull call spread position in Apple. They might not recommend buying Facebook. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check outAnders' holdings and bio, or follow him onTwitterandGoogle+. We have adisclosure policy.
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