Every couple of years, an IPO comes around (this time Facebook) that the financial media proclaims the zeitgeist of the day and most exciting thing investors have seen and ever will see — at least since the last one a few years ago (Google).
Facebook is indeed a phenomenon, with about 12 to13 percent of the world’s population currently using the social networking site in some capacity (over 900 million users out of a world population of just over 7 billion). Of those users, more than half are active on Facebook every day. Such a statistic is incredibly impressive and mania inducing.
What does all this mean for the IPO?
Let’s assume someone can get in at the IPO price. With all the hype surrounding Facebook, the opening IPO range — currently priced at $34 to $38 — will likely only be a faint memory by the time the masses get a piece of the action.
If you can’t get in at the IPO price, you have to actually try to place a value on the company. I know — how annoying, right?
You can try friending (I apologize to all my English teachers ever for using that as a verb) Facebook founder Mark Zuckerberg, but most likely you will have to dive into the numbers, read the S-1 (and all of the amendments to the S-1), and take a leap of faith that Facebook will find a way to expand its user base to the other 87 to 88 percent of the globe it does not touch, and squeeze more revenue out of the users it already has. Let’s take a look at some of the issues.
Facebook by the Numbers … Well Some of Them Anyway
The Financial Times recently published a full-page analysis of Facebook that ran through some of the numbers that are key to the company’s valuation. It even included a Facebook Valuation Calculator that helps you play junior equity analyst by inputting your own assumptions about future performance.
The analysis compared the social networking companyto Microsoft and Google in terms of revenue growth, concluding that Facebook was unlikely toincrease its revenue as quickly as these companies without hurting its margins. To be fair, not many companies can match the margins of these tech titans, but this is the league that Facebook will be playing in.
The FT’s analysis also shows that in 2011 Facebook spent about 70 percent of its operating cash flow on capital expenditures. As the company grows, investors will expect this number to go down.
Another interesting metric that I’ve seen a number of places is “revenue per user.” Analysts who use this metric compare Facebook to some of its Internet brethren, and unfortunately for Facebook, the company is on the low end of the revenue-per-user scale, with only $1.32 per user versus Google’s $9.52 and LinkedIn’s $1.84. The company will have to continuously improve its advertising model to squeeze more revenues out of its users. Recent reports also show the company’s first-quarter profit declined 12 percent while expenses almost doubled from the previous quarter. Investors should expect such lumpy quarter-to-quarter comparisons because Facebook is a young, growing business which is unlikely to grow at a methodical pace. Luckily the company’s corporate governance structure allows the company to ignore the quarter-by-quarter whims of Wall Street. Unfortunately for investors, the company’s corporate governance structure allows it to ignore the wishes of its shareowners.
Finally, the blog Seeking Alpha ran a detailed analysis earlier this week, asking “What Facebook is Really Worth”? The analysis walks investors through a number of different assumptions that lead to a wide range of valuations; based on those assumptions, investors can then decide on a valuation themselves.
Facebook Corporate Governance Is a Concern
Speaking of corporate governance, Bloomberg recently featured an excellent piece on corporate governance at emerging tech firms (along with Google) that highlights some of the shareowner rights challenges Facebook investors would face. Essentially, you have no rights if you invest in Facebook. Through his control of the company’s B shares, Zuckerberg owns over 50 percent of Facebook’s voting shares and can ignore investors’ wishes with impunity. If you invest in Facebook you are betting that Mark Zuckerberg is a technology genius, and if you plan to invest for the long term, you are betting that he will remain one.
Investors should realize that the Facebook board has little power as well. Board members can advise Mr. Zuckerberg, but with his control of voting rights, he can bring on or dismiss a board member whenever he wishes, and only needs to consult the board if and when he chooses to do so. Zuckerberg’s autonomy was demonstrated in a profound way when the Facebook CEO only informed the board of the company’s acquisition of Instagram after he had negotiated the deal by himself.
The Privacy Issue
Facebook is a unique company in that its customers are the product it is selling. Facebook has had trouble in the past with privacy issues and must find a balance that maximizes revenue while not riding roughshod over what privacy its members wish to keep. People may blanch at seeing marketing aimed at them based on information gathered by Facebook that, at best, compromises a bit of privacy or, at worst, borders on creepy. People may gravitate to other social networks that they perceive as less invasive, but for now, Facebook has managed to stay ahead of such concerns.
Your Mother, Your Teachers, Your Boss, and Everyone Else Who Is Not Cool Are on Facebook
One of the challenges Facebook faces is staying relevant in a technology-driven society on the lookout for the next big thing. A generation has grown up documenting their lives on Facebook, without much of a second thought. But youth culture is fickle, and we’ll undoubtedly see social media challengers in Facebook’s future that may successfully attract individuals to a social club that doesn’t include all the lame people they would never want in their club.
Full Disclosure: The author was once on Facebook, but is not anymore because he never used it. CFA Institute has a robust Facebook presence and is open to friending.