Facebook IPO reveals advantages to business model and challenges that lie ahead

Posted by jffcrmr | 0 comments

Facebook has filed papers for what’s expected to be the largest initial public offering ever to come out of Silicon Valley and one of the largest in U.S. history.

Ending months of speculation, the 8-year-old social networking company has submitted registration documents with the U.S. Securities and Exchange Commission that set a preliminary goal of raising $5 billion. Facebook is expected to be valued at $75 billion to $100 billion. Final pricing will not be set for months, and the size of the IPO probably will increase with investor demand. The filing sets the stage for an IPO in May.

So, what does a Facebook IPO reveal about the advantages to the company’s business model and what challenges lie ahead for the company and investors? A thorough examination of the 202 page S-1 sheds some light on both topics.

Facebook by Comparison:

Google is the best comparison for Facebook for a number of reasons, including:

• Both companies developed technologies that revolutionized the world of online advertising.
• Both derived the majority of revenues from advertising, and rapidly developed into global media properties.
• Both surprised some investors and demonstrated their revenue-generating power by continuing to grow at or above 100% Y/Y, even after reaching multi-billion dollar scale.

Facebook also has some key advantages over Google that could allow the company to trade at a premium to the 9x forward revenues Google traded at (on average) for several years after its own 2004 IPO. If one’s basis is a 10x forward P/S (price-to-sales ratio) multiple Facebook may trade at after the IPO, a $100 billion IPO valuation is justifiable, and the company’s value will likely exceed $100 billion by the end of 2012.

Advantages to Facebook’s Model:

• More diversified revenue base - Google still generates +95% of revenues from advertising, Facebook has many more “levers to pull” in E-Commerce and investors will pay a premium for this more diversified base of business.
• Dominant market position; advantages to the operating model - Facebook has an uncommon model where the users create/are the content that attracts other users, and the presence of +800 million (fast approaching 1 billion) worldwide users attracts thousands of third-party app developers to build social software plug-ins that make the social experience on Facebook even more engaging, then pay 30% off the top of all revenues their apps generate to Facebook via the Facebook Credits social currency. It is an enviable model.

The Facebook S-1 and Potential Challenges:

• Margins - For comparison, Google had approximately 40% EBITDA (earnings before interest, taxes, depreciation, and amortization) margins in 2004, the year of its IPO. Facebook’s margins contracted a bit from 2010 to 2011, but still: the company made $1 billion in net income on $3.7 billion in revenue last year, for a margin of 27%. Margins shrank from 31% in 2010, as revenue grew 88% but expenses grew 107%.  Something to keep in mind – net profit tends to be less correlated with stock price for high-growth Internet companies.
• Facebook Credits – E-Commerce revenues - While Google still generates ~96% of its revenues from advertising, the two main methods of Facebook’s revenue gains were advertisements and “payments and other fees” — namely virtual goods in some capacity. For year 2011, advertising was 85% of the Facebook revenue ($3.15 billion, while other payments made up $557 million). This is a HUGE jump over the previous year where $1.87 billion of revenue came from advertisements and $106 million from payments. Essentially, virtual goods grew more than 500% since the start of 2010.
• Growth - The key to Facebook’s valuation is growth — the company turned a profit for the first time only three years ago, in 2009, when it earned $229 million on $777 million in revenue. Those numbers have grown at a staggering rate since, including an 88% growth in revenue from 2010 to 2011. If investors and analysts expect those numbers to grow, a high valuation when Facebook hits the market is almost a certainty.
• International revenues - Facebook generated approximately 56% of their revenue from advertisers and Platform developers based in the United States (down 6% from 2010)  due to a faster growth rate of international users and the expansion of international sales offices and payment methods. Other Internet heavyweights like Google and Groupon already generate more than 50% of revenues from outside the U.S. Facebook maintains a leaner team than Google, and has a very large future upside potential for international advertising revenues, in addition to growth potential in global E-Commerce revenues.

Final Thoughts:

The IPO was inevitable. Facebook had tripped the regulatory wire that forces companies with more than 500 shareholders to disclose almost as much information as publicly traded companies.

Facebook’s proposed valuation would instantly catapult the social network into the ranks of the largest companies, although it still lags far behind established top-tier behemoths Exxon Mobil, Apple, and Microsoft.

The company’s track record of revenue and profit growth–which few other private tech companies can claim–as well as the opportunities that come from its massive reach seemingly justifies the huge value in many investors’ eyes.

 

Author : Jeff Cormier –  http://about.me/jffcrmr

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