What Zuckerberg must do to right the Facebook ship

Investors are starting to panic. CEO Mark Zuckerberg needs to calm the masses while building revenue-generating products.

Zuckerberg's first three months as a public company CEO have been rocky.

All is not well at Facebook. Some have even started calling for CEO Mark Zuckerberg's head. But the panic is premature, and the social network has plenty of time and opportunity to turn things around.

Facebook's stock price has traveled south since its flashy (and disastrous) debut in May. Facebook closed at $19.44 per share on Wednesday, barely half of its $38 IPO price.

Why is Facebook's share price dropping like a boulder off a cliff? M&A specialist Marty Wolf provides an excellent explanation , but I'll summarize the key points:

  • Facebook's price-to-earnings ratio (P/E) for the last 12 months was 72.4, which puts it way above the P/E ratios of Google (20.0), Apple (15.7) and Yahoo (17.0). This would be fine if Facebook's revenue growth were accelerating, but it isn't.
  • Facebook currently makes approximately $5.12 per user on an annualized basis (calculated from its most recent quarterly figure of $1.28 per user). It would need to boost that more than sixfold, to just over $33 per user, with its current userbase (about 900 million users) to justify a $38 share price.
  • Several more lockups will flood the market with Facebook shares, with 1.3 billion shares becoming available for sale in November alone.
  • Facebook's users are going mobile, and Facebook hasn't figured out how to monetize mobile yet.

The result: investors are panicking, and some are questioning whether Zuckerberg is in over his head.

Zuckerberg's job is safe for the time being (he controls a majority of the voting power), but Facebook needs to find a way to turn its stock price around before top employees start to leave.

There is no easy solution to Facebook's woes, though. Its P/E ratio is still well above Google, Apple, and other major tech giants, so there's more room for Facebook drop. It's unlikely that Facebook can reverse its slide until it finds a major new source of revenue (and lowers its P/E ratio).

So that's what Zuckerberg and Facebook must do. The company must launch new revenue-generating products. It doesn't matter whether it's a Facebook for AdSense or a massive payment system -- it just needs to generate revenue. Facebook must prove it can increase the revenue it generates per user.

That won't happen overnight, so Zuckerberg needs to address the market's fears in the meantime. An interview assuring investors that new products are in the pipeline could be a major stabilization factor for the stock. While there's no guarantee of that, his current silence isn't doing the stock any favors.

In the long term, Facebook will be fine. At least, that's what Zuckerberg is betting on as he focuses the team on product. But the stock's shocking drop can only serve as a distraction to his greater goals. He'd be wise to make revenue the priority it should be.

Corrected at 9:29 a.m. PT: An earlier version of this piece incorrectly compared Facebook's quarterly average revenue per user (ARPU) to the annual ARPU that would justify its IPO share price. Facebook's annualized ARPU is currently $5.12; it would need to rise above $33 with its current user base to justify a $38 share price.

 

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