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The Social Network
The ticker for 2012’s hottest initial public offering will be FB, initials with which many Internet users are already familiar. FB is a shortening of Facebook, an 845 million strong social network that would rank only behind China and India if it were its own country. Much like political power in China, ownership of the stock would be concentrated in a few hands, with founder Mark Zuckerberg retaining 57% of voting rights. And much like China, hopes are high for Facebook’s growth.
The buzz has already driven up Facebook stock to a $100 billion value in secondary trading. An investment fund that holds some Facebook shares, GSV Capital Corp (GSVC), popped after the IPO announcement. (Volume for GSVC, for example was 2.6 million shares on January 27th, compared to the somewhat quieter volume of about 50 thousand the week before.) Other social stocks Zynga (ZNGA), LinkedIn (LNKD), and Groupon (GRPN), benefited from Facebook’s “halo” effect at the time of the IPO announcement in late January, as investors seemingly gobbled up anything social to cash in on the craze.
The appropriate SEC filings were made on February 1st, including a preliminary prospectus giving a sneak peak at the company’s financial footing. Facebook had 2011 revenues of $3.7 billion, net income of $1 billion, and 50% operating margins, according to its S-1 filing. Revenues were up 88% last year and 154% from 2009 to 2010.
More breakneck growth would be built into Facebook’s stock price. One financial media source says Facebook’s valuation will likely be anywhere from $75 billion to $100 billion, or 75 to 100 times earnings; Facebook would have to justify this value by sustaining, growing, and monetizing its business (a lot more than the Value Line Average, which had a P/E ratio around 15 recently). Setting the stage for the frantic IPO, the NASDAQ recently moved up to its highest point since the infamous dotcom bubble at the turn of the millennium.
So is Facebook a wise investment, and how does it compare to social media trailblazers who IPO’d before it? If Facebook offers its shares based on a valuation of $75 billion to $100 billion that means it will be trading at about 20 to 27 times its 2011 sales. This is not unheard of; LinkedIn is trading at 18 times sales.
LinkedIn is already profitable, reporting better-than-expected earnings in mid-February. Growth was the strongest in its hiring solutions segment, a natural vehicle for this career social network. This stock has had a choppy performance since the day of its public offering.
The fate of Zynga, a game developer for social networks, is intertwined with Facebook’s. Though it is trying to diversify, Zynga gets 90% of its revenues through Facebook. Zynga stock has performed strongly this year so far, thanks largely to Facebook buzz. The company recently reported its first quarterly earnings. There was a loss under U.S. GAAP, as it ratcheted up research and development investments this year. Time will tell if these investments pay off.
Although Facebook does not have a product to sell like Zynga’s games, or a natural service like LinkedIn’s hiring solutions, its operating margins and profits from advertising are still formidable. But, there could be some headwinds if Facebook tries to bolster its financial numbers. Users, accustomed to the free nature of the service, may backlash against an attempt by Facebook to sell them something or to increase its advertising revenues.
Right now, Facebook is not as effective in generating ad revenue as, say, Internet giant Google (GOOG). Google is posting sales and net income figures that are about 10 times those of Facebook, while its market cap is about $200 billion. This is in spite of Facebook’s intimate knowledge of its massive user base.
Although Facebook has the lion’s share of the social networking market, the Internet is a fast-changing landscape. Facebook’s predecessor Myspace went from the social media pinnacle to obscurity. At the same time, Google already has made a foray into the social world, and is trying to leverage its other popular services to gain a share of the market. Besides Google, the world of social media is a blooming, diverse ecosystem, with many niche players.
For example, Yelp (YELP) is a website where users can evaluate community businesses, such as restaurants in a social environment. It is looking for a valuation of less than a billion with its coming IPO. The suspected valuation would put the company’s worth at roughly ten times its 2011 sales. The company operated at a loss for the last three reported years. It is another player in a social media world that is new, exciting and not for faint-of-heart investors.
In a recent interview, Mark Zuckerberg noted that he promised his employees all along that he would take the company public, giving them a financial incentive. One thing seems certain: the Facebook hype should benefit a social network consisting of early investors and early employees the most.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.