Why the Fuss Over Facebook Doesn't Make It a Home Run

The news this week that Goldman Sachs was privately offering a minority stake in Facebook to new investors—and that Facebook would become a public company by early next year—has set off a buying frenzy, even among people who can't tell "LOL" from a Roman numeral.

If you've been left out, don't fret. Expectations are already so high that most of the future gain already may be gone.

Less than seven years after its launch in a dormitory room at Harvard University, Facebook is already booming past $2 billion in annual revenues, reports suggest—nearly triple its sales from the year before.

Yet to keep growing at anything like that pace, Facebook needs more capital. Employees and investors, meanwhile, also want to turn some shares into cash, say people familiar with the company. Under Securities and Exchange Commission rules, all companies with 500 or more holders of any class of stock are required to register with the SEC, triggering detailed financial disclosures. According to a filing Facebook made with the SEC in 2008, even its terminated employees can retain their restricted stock, so it was inevitable that the company would breach the 500-investor threshold.

So Facebook's best option for selling equity and remaining private was to tap into the kind of wealthy investor network that Goldman can provide. By offering shares to its most favored clients and forcing them to commit or decline in less than a week, Goldman made investing in Facebook seem like a precious privilege. The remarkable price for Facebook's stock, reportedly around $50 billion, or some 25 times the company's revenues, has been set in a closed feedback loop rather than in an open market. Facebook and Goldman declined to comment.

Investors are buying more than hope, of course. With roughly 600 million users and closing in on $500 million in annual profit, Facebook looks unstoppable.

Yet even with such a huge network, the company could falter. "Facebook is going to be extremely difficult to dethrone," says an industry veteran familiar with the company's operations. "But social trends online are completely unpredictable. If a new trend comes along that's really engaging to people and a different way of interacting, then Facebook could become the old way of social networking."

Even if Facebook continues to hit the mother lode of social-network profits, new investors could end up with little to show for it. In January 1875, during the Nevada silver rush, the price of Consolidated Virginia Mine hit $700 a share or a total value of $75.6 million (roughly $1.5 billion today). That was 15 times the company's revenues the year before, according to records compiled in 1883 by researcher Eliot Lord. Over the next four years, investors earned some $42 million in dividends—and, even so, the stock collapsed to $3 a share by the end of 1879. Investors who bought in on the ground floor in 1870, at $1 a share, tripled their money. Those who came later were wiped out, even though they owned a stake in an immensely profitable business.

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