January 06, 2012, 11:44 AM — As Wall Street awaits Facebook's highly anticipated initial public offering, which could come as early as April, investors eager to snap up shares of the social networking giant on the first day of trading might want to do a little research first.
There were two major IPOs last year from companies associated with social media -- daily-deals site Groupon and social games site Zynga. Both have been flops on the stock market (so far), in large part because investors fully recognize the potentially huge flaws in each company's business plan.
Groupon (NASDAQ: GRPN), of course, was a shaky bet from the start. The Chicago-based company is losing money, it ran into problems with the Securities and Exchange Commission last summer over how it counts revenue (it was overcounting), and it's in an untested market that already is showing signs of oversaturation and customer fatigue.
Perhaps most ominous of all, a recent study by Susquehanna Financial Group and daily-deals aggregator Yipit found that more than half of the merchants (52%) who have done daily deals through Groupon don't plan any more for at least the next six months, and another 24% plan to run just one deal during that time.
Which means two things:
1) Groupon is having serious customer retention problems. In a market with many competitors and low barriers for entry, that's dangerous.
2) For Groupon to continue growing revenue, it needs to keep finding new merchants or rely on the 24% that are regular, repeat customers.
Wall Street apparently isn't confident that's going to happen. Groupon shares were trading at 17.63 early Friday (after hitting a new low of 17.50), down 43.4% from the 31.14 that some shrewd investors paid on November 4, when the company went public. The stock also is down 32.5% from the first-day close and 23.5% from December 27.
Zynga (NASDAQ: ZNGA), meanwhile, on Friday set its own new low since going public on December 16. Shares reached 8.64, or 24.9% below the 11.50 they peaked at in their first day of trading.
(Click this link for my thoughts on IPO first-day investing.)
Zynga had the largest Internet IPO since Google's in 2004, and while it raised $1 billion, shares finished the first day below the offer price, an almost unheard-of occurrence in the big-time Internet IPO game.
Unlike Groupon, Zynga is profitable. But like Groupon, Zynga's business plan carries sizable risks. Particularly, about 94% of Zynga's revenues come from people who play its games (FarmVille, CityVille, Mafia Wars, etc.) on Facebook.
In addition, as Zynga itself notes, a small percentage of its players account for nearly all of the company's revenue.
What happens when these get-a-lifers have to find jobs, or merely get bored with the games that are consuming all their time and energy?
That's the perpetual threat facing Zynga, which is now in the position of having to crank out more titles to keep the simpletons amused. The problem is, many people think Zynga is sacrificing quality for speed to market. The company's latest offering, Hidden Chronicles, is a lazy ripoff of an existing game, according to Forbes contributor Paul Tassi, who writes:
Zynga has had time and money to make their game more polished than their competitors, but once again, it shows that the company refuses to innovate in any way, and is merely a follower when it comes to ideas and game design.
Of course, you can be a follower and still be successful merely by meeting the low expectations of your customers. The problem with that strategy is low expectations also can easily be met by competitors.
So what does this mean to potential Facebook investors? It means they must resist getting swept up by the hype and excitement over the "biggest IPO we've seen in years," as one analyst put it, and look at the numbers when Facebook files its S-1.
And what they'll see, if they read carefully, is that Facebook's alleged 800 million users are a mirage. Facebook defines "active users" as people who "have logged in during the past 30 days." Are they kidding? How many of those 800 million log in every day? That's an active user, not someone who logs in once a month.
Further, and I've been beating this drum for awhile, what's to stop heavy Facebook users from eventually burning out on the service or gravitating to another social networking site that is more attractive than Facebook in some way? It's hardly unprecedented (right, Myspace?).
Facebook's underwriters will do everything they can to stoke rabid interest in this IPO. They will tell you Facebook is the greatest, most promising, world-changing, dominating, profitable and enduring company in the history of the planet.
Great. Then Facebook should still be here a month after the IPO, when shares can be had a more reasonable price. At the very least, investors, remember that.
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