Facebook's billion-user drive could hit China's internet wall

The social networking site is proving less popular in North America even as it gains a hold in other highly populated countries. But the biggest nation could be too much to chew

With luck, this is 1997 all over again.

But some fear we are revisiting 2000. The difference is whether the dotcom boom has another three years before the bubble bursts. Investors are buying into internet stocks with a new frenzy but there are signs that consumers are tiring of the current technology.

Evidence emerged last week that Facebook is fading in its original markets. More than 100,000 British users switched off from the social networking site last month, but in its North American heartland the disenchantment was even greater. The number of Canadian users collapsed by 1.52 million or 8 per cent, according to Inside Facebook – a website that monitors the website – while the US customer base collapsed by six million.

That still leaves nearly 150 million US users of the network, but the previous exponential growth is slowing, says Eric Eldon of Inside Facebook. Usage in nations such as Russia and Norway fell too, he says. "Facebook appears to have had fewer monthly active users at the start of June than at the start of May in the US and a few other countries. Canada, the UK and other early-adopting countries have alternatively shown gains and losses starting in 2010. Until then, growth had generally been much steadier."

From its base in Palo Alto, California, Facebook admits the figures are gleaned from its own advertising information but claims this was not designed to track the network's overall growth. However, according to another monitoring source, Compete, not only is Facebook usage falling, but there have also been declines at its Twitter and MySpace rivals too.

Facebook is still growing, picking up customers in developing countries even if it is losing them in the mature markets. Worldwide, it gained 11.8 million new customers last month – more than offsetting its losses – taking its global customer base to 687 million people. But that is less than the 20 million new accounts added each month last year.

However, such a figure represents astronomical growth since Harvard student Mark Zuckerberg and three colleagues developed the network in 2004 for swapping personal details with fellow undergraduates. After opening it to other Ivy League universities, Facebook took off across America, embracing all social classes, then spread internationally. It took four years to reached 100 million users but only five months during 2009 to go from 200 million to 300 million.

Half of Americans now have an account – representing a quarter of Facebook's members – but last month's loss in the US is equivalent to 10 times the population of Boston, where Zuckerman created the phenomenon. If Facebook has many more months like that, it will not only be shrinking at home but users elsewhere may question whether they still want to jump aboard this bandwagon.

Facebook is a private company, with Zuckerman owning a quarter of the shares, but speculation of a flotation has intensified as the price of other internet-based companies has soared. A share offer pencilled in for 2013 is now expected next year by many.

Bill Gates's Microsoft cannily bought a 1.7 per cent stake in Facebook in 2007 for $240m (£150m), implying a $14bn value for the company, but the figure has rocketed since then. Goldman Sachs bought a stake at the start of this year that gave the company a $50bn valuation. Recent share deals on the secondary market put its worth at about $65bn and a flotation could raise that to $100bn, making it bigger than tech stocks such as Hewlett-Packard or Cisco.

Yet Facebook's cashflow turned positive only two years ago and, despite that enormous customer base, it generates revenues of only just over $2bn a year. Its valuation thus compares with the unsustainable prices put on technology, media and telecoms stocks at the end of the 1990s when companies without any earnings were valued on a multiple of sales. Such optimism is evident again now. The $8.5bn that Microsoft bid this year for Skype is 10 times the internet phone company's annual turnover. LinkedIn, another social network, had a $3bn flotation price that is 13 times sales and Renren, a Chinese network listed on the US Nasdaq market, trades at 90 times its annual revenue. Meanwhile Groupon, a discount sales club, is preparing for a flotation later this year that could value it at up to $20bn.

The lesson of the first dotcom boom is that many companies fail to meet their high expectations. Businesses priced with payback periods of two or three decades can fail within two or three years. Google survives, valued at $170bn, as does Amazon at $85bn, eBay at $39bn and Yahoo! with at $20bn, but ventures such as Letsbuyit or Boo.com disappeared when the bubble burst.

AOL's top-of-the-market merger with Time Warner in 2000 was valued at $100bn but the remnants of the business are now worth just a quarter of that. The early networking site Friends Reunited was bought by ITV for £175m in 2005 and sold four years later for £25m after its customers moved to the next generation of providers, including Facebook. MySpace has proved an equally disappointing purchase for Rupert Murdoch: News Corporation paid $580m in 2005 but he was unable to sell it for even $100m this year.

Facebook overtook MySpace in 2008 and claimed more visits that Google last year but customers, especially youngsters, have little loyalty in this sector and have shown themselves immune to the advertising that would generate greater revenues.

Mr Zuckerberg wants to raise his customer base to a billion but his most critical unofficial monitor, Mr Eldon, fears Facebook may be reaching saturation. "By the time Facebook reaches around 50 per cent of the total population in a given country – plus or minus, depending on internet access in that country – growth generally slows to a halt."

So far, Facebook has offset its losses by expanding into large countries such as Brazil – where 10 per cent growth in May lifted its base to 19 million – or Turkey and India, where it has more than 25 million users. Indonesia's 37.9 million customers make it second only to the US.

But to reach a billion, Mr Zuckerman needs to penetrate China's enormous market and that's problematical. Andy Beal, a manager of the Henderson TR Pacific investment trust, says: "It's going to be difficult for Western groups to get in there. The biggest issue for them is the problem Google had in China. The Chinese market is controlled. Beijing does not want a free for all as they had in the Middle East: social networks could lead to all sorts of undesirable coming together of opponents. Western companies can partner with local providers but they'd have to compromise. There is a risk that they will be asked to sign up to measures that are inconsistent with their own values."

Google withdrew rather than agree to controls. But even companies that do enter this market will find competition from local social network groups. Mr Beal invested in Sino.com which has launched the Weibo micro-blogging site. "It's a Twitter clone that went from a standing start to 100 million users in about 18 months," he says. Hong Kong-based Tencent has another 100 million users and Renren claimed 160 millionin February beforeit floated.

And Mr Eldon fears that if Facebook compromises its principles to gain members in China, it could accelerate its losses elsewhere. "China could give it access to hundreds of millions of users and compromise its reputation in the US and many other countries around the world," he warns.