Brokers at Morgan Stanley and the other underwriters of the Facebook IPO didn’t realize how many Facebook friends they had until they were allocated shares for individual accounts. Everyone wants a piece of the action.

High demand and low supply will guarantee a succesful IPO, but what are the implications of the IPO on tech M&A overall?

There are three important factors at work. First, how much support will Facebook get from the market after the shares are listed? Two, what will Facebook have to accomplish in the areas of innovation and M&A in order to maintain their leadership position? Third, what strategies will the Facebook competitors pursue in order to stay relevant in world where Facebook has translated its giant user base and market recognition into one of the largest IPOs ever?

Let’s consider the first question: will the market continue to support Facebook at or above the level of the IPO price? This is important because if the stock trades up and stays up, the VC and private equity communities will remain highly motivated to invest, acquire and consolidate companies that could potentially take advantage of the confidence and buzz that the Facebook IPO will create. (After an initial jump on Friday, the stock settled near its $38 per share offering price).

Shares of Facebook ended just above their $38 offering price

Underwriters are not allowed to participate in short sales for 30 days after the IPO, and the institutions and individuals who are allocated shares will not rush to lend shares in support of short sales. That means that there will be limited or no pressure on the stock price from short sellers for several months after the offering (not to mention that it would take an especially cynical investor to take a chance on short selling in the face of the largest and most anticipated IPO ever).

The market will be biased toward supporting the stock. Even with the relatively large percentage of shares being sold directly by investors (Goldman has indicated they will sell up to half of their position, and Microsoft will unload enough shares to recoup their initial investment), Facebook will find support from the market, as long as they continue to execute well.

Execution will require a motivated team. The attention of senior team members who have converted their paper millions into cash in the bank and liquid shares may wander from progress in the office to vacations in exotic locations. Google faced this problem after their IPO and managed aggressively to mitigate it.

They appointed HR “watchers” to shadow key team members and help them stay motivated. They actively discouraged team members from watching the stock price during working hours. They discouraged them from showing up to work the day after the IPO in fancy new cars (I have a friend who purchased an Aston Martin from a Google millionaire who grew tired of hiding the car across the street from the Google offices).

Even if Facebook takes similar steps, it will be hard for all of the newly minted millionaire not to feel that they have arrived, and their journey is over.

Execution will require growing ad revenue. As long as the Facebook user base continues to grow, advertisers will be drawn to the platform as a way to reach a valuable demographic.

However, many veteran Facebook advertisers are starting to question the efficacy of embedding ads on the social platform. With the exception of certain niche areas, it appears that the ads do not produce high click-throughs. Google has an advantage in this regards. People come to Google looking for something. Often it is something they want to buy. Users come to Facebook to interact with their friends. The ads don’t answer their search question. On the contrary, they get in the way of enjoying the social experience.

Nat Burgess

The result will be that new advertisers will continue sign up, but veteran advertisers will need to see real results, or they will take their ad dollars elsewhere. Facebook will have to figure out how to deliver a better result for advertisers, or they will eventually start losing more existing advertisers than they add in new advertisers. The key word is “eventually;” even if Facebook ads prove ineffective, ad revenue will continue to grow until attrition overtakes new advertiser sign ups. This inflection point could be moths, or even years away.

This brings us to the third point, regarding innovation and M&A. Let’s accept for the moment that a) the Facebook user base continues to grow, and b) banner ads on Facebook do not produce a strong result for advertisers. The result will be tremendous pressure on Facebook to find new ways of monetizing the customer base.

Our eyes are on the innovative companies operating in the advertising and media sector that are cooking up innovative technologies and strategies to bridge the gap between Facebook users, and vendors that want to sell them products and services. We see this as one of the hottest areas for M&A and innovation in 2012 and 2013.

The same goes for Facebook competitors. Scale matters, a lot.

Social media users don’t have time to curate multiple social profiles. The slow growth of Google+ supports this fact.

However, a niche social platform that yields much higher transactional revenue per user could become a high-value M&A target, even if their scale is only a fraction of Facebook’s. Therefore our eyes are also on emerging niche platforms and services that are optimized for revenue, rather than scale.

Finally, let’s consider the next frontier of social interaction, which is clearly video. Analysts agree that video traffic will expand exponentially over the next few years. It happened with photos, and Facebook and Google both responded – Facebook by acquiring Instagram, and Google by acquiring Picnik.

Video is harder. The files are big. Online editing poses technical problems, because a simple fix that turns one section of a video clip into an improved or delightfully skewed snippet, could destroy another section of the same clip if the content, color balance, lighting, or other dynamics are significantly different.

There is room for innovation here. There is also room for innovative upstarts, like Eyejot in Seattle, to change the way video is used for communication, and shared between users.

When leaders start to emerge in the area of online video editing and sharing, they could drive the next billion + transaction – a la Instagram.

Nat Burgess is president of Corum Group, a Seattle area M&A advisory firm. He will be our guest on the GeekWire radio show and podcast this weekend, talking about the Facebook IPO.

Previous Facebook coverage on GeekWire: Why I’m betting my retirement on Facebook stock today… Open Letter to New Facebook Millionaires: Pay off mom’s mortgage! (And 5 other tips)… A little piece of Facebook: Would you invest in Zuck’s big IPO?… After all-night hackathon, Facebook rings opening bell

Comments

  • http://www.facebook.com/profile.php?id=94500172 Kyle Kesterson

    Yeah! This article makes me feel even better that Freak’n Genius is creating the most innovative and fun tool for animated video content.. ever.

  • Guest

    “Let’s consider the first question: will the market continue to support Facebook at or above the level of the IPO price”

    Based on today’s action, which saw the underwriters having to pull out all stops in order to keep the stock from closing below its offering price, the answer is absolutely not. It will trade off at least 25% in the weeks ahead.

  • http://wac6.com/ William Carleton

    Nat, cool post. In terms of where FB means to go with advertising, based on the disclosures in the IPO prospectus and the road show video, it seems clear that management (well, below Zuckerberg anyway) wants to take the advertising into the parts of the UI that users won’t ignore – their individual news feeds, on the desktop and on mobile. All kinds of interesting question get raised by that…

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