By Socrates Alvarez, Investopedia: Since its Securities and Exchange Commission (SEC) filing in early February, news of Facebook’s initial public offering (IPO) has been associated with words such as “overvalued” and “overhyped,” and more or less insinuated as a harbinger of a second dotcom bubble. Its preliminary $100 billion valuation trumps Google’s colossal initial IPO market cap of $23, leaving some observers left wondering what warrants such a huge price tag. However, despite the apprehension of many tech investors, this upcoming spring, Facebook’s stock release will undoubtedly be the largest tech IPO in years, raising at least $5 billion.
The prospectus filed to the SEC lists numerous risk factors that echo the public opinion of Facebook’s current position in the online world – risks such as the inability to retain existing users, a scenario which was realized in May of 2011 as 7 million American and Canadian users left the site. Yet there were a handful of items listed in the filing of notable interest that could, if executed well, bring some justification to the company’s high valuation. However, on the other hand, these factors could also just end up giving Facebook a black eye.
Revenue Per User
With its purported 845 million monthly active users, Facebook lords over other related social networking sites, such as LinkedIn, which has an estimated 49 million monthly views, Twitter with 92 million and Tumblr 47 million, compared to Facebook at about 150 million monthly views. In its prospectus published earlier this month, Facebook has earned revenue of $3.7 billion. As a company that relies heavily on advertising to its massive user base, this equates to about $4.38 of revenue per active user on the site.
Assuming they can double their active users to 1.69 billion (which can be tangibly achieved if China opens its online borders) at $4.38 per user, Facebook could earn $7.4 billion; if they can double the $4.38 in addition, they will be looking at $14.8 billion. To put this in perspective, Google earned unaudited revenue of $37.9 billion in 2011. Thus, the questions remain: is Facebook capable of growing its active users? Or even squeezing out more than $5 a person?
The Facebook Platform
Unlike many of its social media peers, Facebook provides a platform for third party developers to create and integrate apps into the social network’s infrastructure. In 2011, Facebook derived approximately 12% of its revenue from casual gaming company Zynga, which develops social apps such as “CityVille,” “Zynga Poker” and “Mafia Wars 2.” The company is financially supported through ad revenue and income derived from the sales and purchase of virtual goods. In its 2011 fourth quarter earnings report, Zynga collected revenue over $311 million, barring its net lossof $435 million due to expenses.
With each transaction Zynga makes, 30% of it goes towards Facebook as per their five-year commitment. Assuming this relationship is maintained, this can bode well for both groups. However, recent speculation shows that Zynga is moving away from Facebook and hopes to determine itself as an independent game publisher. This may put a dent in the earnings for Facebook, unless they can bring in other developers and third party companies into the foray and continue the monetization of their platform.
Growth and Facebook Mobile
In the interceding year between the end of 2010 and 2011, Facebook saw a 39% growth in monthly active users; notably in Brazil, where Orkut is the social media site of choice, growth reached 268% from the previous year as 37 million users signed on. As mentioned before, China’s population is a potential area for Facebook, however in order to penetrate that market several regulatory hurdles need to be overcome, as well as compliance to foreign laws regarding censorship – not to mention competition with their own social media sites such as RenRen and Sina. If in the foreseeable future Facebook in its intact form can enter China, billions of potential users will be accessible and subsequently, available for ad targeting.
Moreover, in 2011, about 425 million users accessed Facebook via a mobile device, which at the moment does not draw any ad revenue. If it chooses to capitalize on this venue, it could potentially draw significant revenue. Conversely, given the relatively small screen real estate on most smartphones, this may deter users from accessing the site in this manner.
The Bottom Line
In spite of criticism regarding its valuation, the fact remains that Facebook has captured a significant percentage of the online tech market and continues to be a major player in the recent stream of web 2.0 stocks. It maintains a user-friendly interface, frequently seeks to innovate and expand its presence on the internet and has become a staple in the lexicon of modern day conversation.
Facebook could potentially fail to mirror the evolution of Google, which emerged as an entity entirely different than initially anticipated, if the three reasons listed above are not deeply invested in by its developers. However, it could very well go beyond popular negative expectations if it ends up being successful in the face of its business risks. Either way, the months following Facebook’s IPO release will prove to be interesting.