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Facebook's Plan to Spot the Next Big Social App

By Adam Levy – Jun 14, 2020 at 12:30PM

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Facebook is starting a venture capital fund to invest in nascent startups.

Mark Zuckerberg has done a pretty good job of keeping his finger on the pulse of social media and related technologies. But as Facebook (META -1.39%) grows bigger and expands its reach, it's getting harder and harder for the company to stay ahead of the curve. Meanwhile, the company is coming under increasing regulatory scrutiny, so big acquisitions like those it made with Instagram and WhatsApp may be harder to pull off going forward.

That may be why Facebook is reportedly hiring tech investors for a venture capital fund to help it spot the next big thing in social media and potentially acquire it (or at least a substantial stake in it) before it would raise antitrust issues. A Facebook spokesperson said the company has already hired an investor to lead the multi-million dollar fund, but didn't confirm the size of the fund, according to Axios.

Facebook is following in the footsteps of fellow FAANG stock Alphabet (GOOG -1.29%) (GOOGL -1.06%), which has operated a venture capital fund since 2009. Such a venture capital fund can often uncover potential acquisition targets. For example, Google Ventures invested in Nest before its parent company acquired the entire business in 2014. Facebook may find similar successes, and it has plenty of cash to pursue it.

Mark Zuckerberg holding a microphone.

Image source: Facebook.

New Product Experimentation Team

Last year, Facebook created a group to launch experimental apps, hoping to strike a chord with smaller niche audiences compared with the broad appeal of its main apps. Those apps include an icebreaker app for teens (Bump) and a group music listening app. It also developed apps for podcasts, travel, workplace services, and newsletters.

The venture capitalist fund will fall under the New Product Experimentation Team, indicating that Facebook may be looking for more experimental apps with the potential to blow up in popularity. "Other bets," to use an Alphabet term.

Finding innovative apps early on could help Facebook stay ahead of the competition. Smaller competitors like TikTok and Snap's (SNAP 0.64%) Snapchat have managed to carve out highly valuable and engaged audiences. While Facebook eventually managed to co-opt one of Snapchat's main features -- Stories -- its efforts to copy TikTok (Lasso and Reel) have fallen flat. 

TikTok's parent company ByteDance is reportedly generating revenue on par with Facebook's Instagram, although this includes operations in China, where Facebook doesn't operate.

The ability to identify similar apps before they build a massive audience can at least give Facebook an edge in developing new features or acquiring possible competitors before they get big enough to rebuff Facebook's advances, as was the case with Snap. And even if Facebook can come to terms with larger competitors, it'll face increased antitrust scrutiny in today's environment.

A growing cash pile

Facebook is sitting on an increasingly large pile of cash. It currently has about $50 billion in cash, and that's after a sizable investment in Jio and a $5 billion settlement payout to the FTC related to user privacy violations. What's more, it's generating tens of billions of dollars in free cash flow every year.

Taking just a tiny portion of that cash pile to invest in speculative start-ups could provide additional value to shareholders at very little risk compared to the size of its cash balance. Alphabet's GV fund started with just $100 million. It now has over $4.5 billion in assets. Its Capital G fund, founded in 2013, started with $300 million.

To put that in perspective, Facebook is investing $100 million in small business grants and another $100 million in local news outlets. And while its core advertising business is closely tied to the survival and success of small businesses and its users rely on local news stories, Facebook could arguably see equal benefits from an ability to stay in touch with start-ups in its space.

A small investment now could provide great returns for Facebook either in an acquisition, a stake in a fast-growing company, or a better ability to understand what types of features might entice its own users and improve engagement.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares) and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Facebook. The Motley Fool has a disclosure policy.

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