Is Facebook losing its glow?

The social networking site is still growing -- but that also means serious growing pains.

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By Jessi Hempel, writer

CEO Mark Zuckerberg

(Fortune Magazine) -- It's been a busy couple of months for social networking site Facebook. CEO Mark Zuckerberg appeared on the cover of FORTUNE (dressed in a tie, no less) and shared with us his plans to turn Facebook into the next digital communications platform. Soon thereafter he landed on Oprah Winfrey's couch to offer a tutorial on the site he'd initially built four years ago. In March the company launched a redesign that a vocal group of users roundly criticized. A few weeks after that chief financial officer Gideon Yu resigned unexpectedly, prompting bloggers to speculate that the company must be readying itself for a public offering.

Meanwhile the site has kept adding users at a rapid clip (the redesign has not kept newcomers away), and analysts are starting to raise questions about just how much Facebook is spending on infrastructure to maintain the large site.

It is hard to know much about Facebook's financial situation, because the company is privately held, and its management team has long been reluctant to address the issue of profits. Until now, executives and investors alike have said they place a priority on adding users and getting them to spend more time on the site. In my February interview with operating chief Sheryl Sandberg, she made it clear that the company was very focused on making money specifically so that it could continue to fund its user growth. And early board member Jim Breyer, who put in $1 million of his own money and $12.7 million from an Accel Partners fund, told me he wasn't demanding or even expecting immediate economic returns, saying profitability is "a key focus but there has never been a very specific time table."

Indeed, the company has a deep well of capital to fund its business. It has raised more than $400 million in financing so far. Its largest investor is Microsoft (MSFT, Fortune 500), which paid $240 million in 2007 for a 1.6% stake in the company, giving Facebook a valuation of about $15 billion. Hong Kong billionaire Li Ka-Shing also invested $120 million at the same valuation. (The company's internal valuation as of last June was $3.7 billion.)

But analysts posit that the business itself is becoming increasingly expensive to run. Facebook reports users are uploading more than 850 million photos each day and more than eight million videos. That's a lot of server space.

(And Facebook may not be able to make a return on all those new users. Some 70% of the site's members come from overseas, and many of them hail from countries where there is no real potential for drumming up advertising dollars.)

Will Facebook's 2009 revenues be enough to fund this growth? In 2008, the company brought in an estimated $280 milion. Most of that came directly from banner ads, and a substantial chunk was still coming from a deal with Microsoft in which the Internet behemoth sold traditional banner ads, which cost as little as $0.15 cents per one thousand ads shown to users.

But the company has said that it is on track to beat revenue projections and make 70% more than it did in 2008. In the past year, Facebook has doubled its sales team to more than 130. And a quick scan of the source code for the site's ads would confirm Facebook's assertion that the Microsoft deal accounts for an ever smaller number of the ads the site serves up.

Facebook is in fact seeing positive results with a new ad format it launched last fall, the engagement ad. A good case study comes from Vancouver, Wash.-based pizza restaurant Papa Murphy's, which ran an ad offering a free pizza to anyone who "became a fan" of the restaurant on the Facebook page it created. Users received notifications in their newsfeed and then were directed to the Papa Murphy's Web site to get their pie.

More than 131,000 users became a fan of the national pizza franchise saw traffic to its site jump 253%. And within two weeks, 1,200 people had posted to the site's wall. As Facebook's user base grows, advertisers continue to experiment with these types of ads even as they're pulling back in other areas.

Facebook's popularity seems not to have diminished: the company says more than half of its 200 million active users log on every day. And users spent 178 minutes on the site last month on average, according to Comscore, up 5 % from the previous month.

With so much momentum, will Zuckerberg look to go publlic soon? When Yu left the company, the Wall Street Journal quoted Zuckerberg in an internal memo saying the company would look for a new chief financial officer "with public company experience who can help take us to the next stage in our growth." Indeed, Zuckerberg has always alluded to an IPO, turning down early acquisition offers from large Internet companies. But Zuckerberg isn't revealing his plan. Any speculation as to whether Yu's departure suggests Facebook is hastening its plans is just that: speculation. To top of page

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