The Myth of Profits

Last night I made the quip:

It’s the same problem that Facebook and Twitter face — massive user base with no idea how to profit from it.

I was pinged later with this comment from Moncef Belyamani:

Such a bold statement, yet so wrong. It took me less than a minute to find this key paragraph in a New York Times DealBook article from January […]

The link that he provides states:

Last year, Facebook recorded revenue of approximately $2 billion, with roughly $400 million in profit, according to people briefed on the company’s results. That is up from $220 million in earnings on $770 million in sales in 2009.

At first glance it would appear that my initial statements about Facebook are way off base. Here’s the key passage in the above quote from the New York Times: “according to people briefed on the company’s results.”

In other words no one outside of private investors has seen Facebook’s financial statements, they have not been independently audited, which means they are far less reliable than what these companies once reported:

  • Lehman
  • AIG
  • Worldcom
  • Enron
  • Madoff
  • Arthur Anderson

I think you get where I am going here.

I am not saying that Facebook is cooking its books in any way, but I am saying that right now not only do we have no way of verifying that they aren’t, but our “information” is also being sourced from people who stand to gain from a higher perceived value of Facebook.

This “information” is likely coming from a private shareholder of the company. They are the only ones to gain from leaking this data — if others value Facebook higher because of this then the secondary markets that trade these private shares will only increase the value of a Facebook share, thus making that investor richer.

Perhaps though you still think everything I have stated is bunk. Take this into consideration then: if Facebook is profitable then why does it still need to raise capital through private investing? In the same NYT article they talk about the $450 million that Facebook raised in additional capital. Are we to believe that they can’t continue along their current path with the mythical profits that are being made right now? That they actually need to double what they make to sustain growth? Or is it that they really are not profitable? Or is it one and the same?

You could also believe that the company needs that extra cash to expand and grow faster than they could without — if that’s the belief do we really think that they only need $450 million? Wouldn’t they be better suited for a public IPO where they stand to be infused with billions? Of course a public IPO would mean full auditing and disclosure of their financial statements and release to the public. Which in turn would mean potential investors would get a true picture of their value.

I tend to believe the following about all private companies:

  • Information reported by interested parties is unreliable.
  • Companies that are still raising money are not profitable.

You may disagree, but the fact remains that hearsay is not permitted in court for a reason.

[Updated: 5.10.11 at 6:37 AM]

On Twitter I was pointed to this article, which states:

The financial statements were not audited and offered little detail about how Facebook generates it revenue, said the source, who did not want to be identified because he had signed a non-disclosure agreement.

Now Goldman Sachs has every reason to report accurate numbers, but it still stands to reason that any profit currently being made is:

  1. Not enough, thus the additional capital.
  2. Without a full operational breakdown it is hard to say what the net income they are reporting reflects — there are too many ways to report things that can substantially change the outcome.

It is of course possible that Facebook is making money, without proof though I am inclined not to believe that — and you shouldn’t buy into it either.

Originally posted for members on: May 10, 2011
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