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Andrew Sissons
Researcher, Big Innovation Centre
T 020 7976 3609
Andrew  Sissons

Will Facebook’s flotation leave it in the stratosphere?

Authors: Andrew Sissons Andrew Sissons

02 February 2012

Facebook’s stock market flotation is a big deal. The social network is one of the world’s most iconic companies, and it plays a prominent role in many of our lives, but up until now we’ve known precious little about how successful Facebook is as a business. Last night’s announcement changed all that.

Facebook’s decision to issue shares will tell us two key things about the company. First, Facebook has had to release information on its financial performance, about which there has been widespread speculation in the past. We now know it made around US$1 billion of profit in 2011, from revenues of US$3.71 billion. Second, investors’ response to the stock offering will give us a clue as to how valuable Facebook really is. The more they value the firm, the more the share price will rise.

To some observers, the idea that a virtual company like Facebook could be worth US$100 billion is extraordinary. A leader in the Economist back in May last year warned that we might be headed for a repeat of the Dotcom Bubble, with companies like LinkedIn and Groupon being valued at billions of dollars.

There may be something in these warnings, but there are also some important differences to last time. The Dotcom Bubble of a decade ago saw wild speculation on a number of similar internet companies that did not have clearly established revenue streams. Investors were blinded by the power of technology, and ignored the hard process of turning a website into a profitable business. Many of these companies had potential to make money (indeed, Amazon ended up doing so at a grand scale), but they hadn’t all worked out how to do it systematically.

Facebook is in a different position. Yes, its implied valuation is astronomical given its current revenues. But it has proven, after years of work, that it can make money, even while it makes nothing and gives away its services to customers for free. Of course, it will need to do this on a larger scale, but that should come with time.

There is a lesson here for nascent digital businesses. It is possible to make huge amounts of money on the web, but it cannot be taken for granted. Turning users into cash requires bold thinking, careful positioning and a clear plan. Do it successfully, and the returns are enormous.