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Why a Facebook IPO Could Flop

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Since Facebook is increasingly reliant upon emerging markets for growth in the user count, that revenue-per-user number is going to drop over time.

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So Can Having 500 Million Users Actually Be a Bad Thing?

According to Facebook's fact sheet, the company has over 500 million active members, which it defines as "users who have returned to the site in the last 30 days."

And Alexa, Quantcast, and Compete all rank Facebook as the second most-visited site on the Web.

Facebook is big -- very big -- and that means we need to start wondering just how much bigger it can get.

Now, I did some playing around with Facebook's advertising application myself to confirm numbers I'd been reading across the Web, and some things were obvious.

Relative to population, Facebook penetration is very high in developed countries like the US, UK, Canada, Spain, Italy, and France. This lends credence to the idea of slowing, or even potentially declining user counts in some of these markets. At some point, you just start running out of bodies.

On the other side, Facebook penetration is fairly low in many emerging markets including Africa, as well as a few highly populated countries like China and Russia, which have their own popular social networks.

The US Census Bureau says that there are about 6.9 billion people on planet Earth.

So as of now, about 7% of the human race are active Facebook users. That sounds like a low penetration rate (which normally implies a high level of potential growth), but think about these numbers:

1. World Bank researchers concluded that 95% of the developing world's population lives on less than $10 a day.

2. According to the Food and Agriculture Organization of the United Nations, 925 million people are undernourished.

3. The CIA says that 785 million people can't read or write.

Now it's entirely possible that Facebook could eventually grow to 2 or 3 billion users, capturing a big chunk of the 5 billion-plus people using mobile phones, PCs, and other devices.

The problem comes in that future growth in the user base will be coming from less-affluent areas of the world, which means less revenue-per-user.

The latest rumors have Facebook bringing in $2 billion in operating income on $4 billion in revenue this year. Assuming these numbers are true, Facebook is bringing in about $8 for every active user.

The exact numbers don't matter. My concern is that since Facebook is increasingly reliant upon emerging markets for growth in the user count, that revenue-per-user number is going to drop over time. What may be $10 per user in the United States could easily be $1 in Bangladesh.

So while the user count could theoretically grow six-fold from here, the revenue base may not grow with it.

That means potential multiple shrinkage as investors will be forced to focus on a terminal-growth number for the user base.

Remember the valuation numbers that are being tossed around for Facebook these days. $85 billion. $100 billion. Hell, even $50 billion assumes a ton of growth over the long run.

Now big bucks have been made by the smart, rich, and well-connected people that got in early.

But sooner or later, there just aren't going to be many more people signing up for Facebook. And who wants to be buying the stock at that point?

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No positions in stocks mentioned.
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