Wednesday, January 5, 2011

Maybe Facebook Just Wants to Keep Mum

The SEC is reportedly interested in Goldman Sach's recent deal with Facebook to invest around $500 million and maybe up to $2 billion, some of which will be raised from well-to-do investors. A lot of speculation has popped up in the financial press about what Facebook is doing and why the SEC might be nosing around. Commentators harrumph about the burdens of complying with the federal securities laws and insinuate that the SEC's interest may amount to regulatory overreach that interferes with financial innovation. They imply that Facebook and GS may be fashioning a brave new financing structure for companies that don't want to be forced into the SEC's 1960s vintage regulatory model, and that the SEC is poking around to protect its turf.

The truth may be a lot simpler. Facebook hasn't publicly defined a clear business model. There is good reason to suspect it doesn't have one. It doesn't sell anything to users, and derives much of its revenue from banner advertising. Banner ads aren't generally viewed as the wave of the future for websites. So Facebook is most likely a work in progress.

Its biggest rival is Google, and Facebook doesn't participate in Google's targeted advertising programs. If Google could place targeted ads on Facebook, it might be able to collect enough information to develop its own, improved social network (and Google has the cash--maybe $30 billion plus--to do it). Facebook might, in effect, provide Google with the means to undermine Facebook.

Facebook could try to develop its own targeted advertising program (after an early failure in 2007). But that would take a lot of work, and would put it in direct competition with Google and Google's $30 billion cash hoard. Facebook may be an aircraft carrier to Google's battleship, but an aircraft carrier doesn't want to get within range of a battleship's big guns. So Facebook is probably still figuring out what its principal revenue streams will be.

The SEC's disclosure regulations would require Facebook, if it went public, to reveal a lot about its business activities and risks. First and foremost, Facebook would have to report detailed financial information; and the impression one gets is that Facebook isn't a gusher of net profits yet. If its business model is still a work in progress, it won't have the most glowing picture to paint. That would translate into a less than meteoric rise in its stock price.

A company doesn't go public until it's got a good story to tell about itself. That's how insiders get juicy valuations for their shares. Facebook has little incentive to try to develop a new financial paradigm to go "public" in a private manner, because it wouldn't maximize share price right now. There's a news report on saying that Facebook will use the money it's raising from Goldman to buy back employee stock and keep the number of investors below the 500 shareholder level where Facebook would have to start filing the reports required of a public company. Assuming that's true, the whole point of the GS deal is to avoid going public. That would seem to make sense, from a business standpoint. The SEC will find whatever it finds in its inquiry, and the possibility that GS and Facebook might have tripped over a regulatory requirement somewhere cannot be discounted. But the whole thing may be, not a sneak IPO, but a bid to stay private until Facebook's founders can hear the cash register ringing really loudly.

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