One of the hottest stories in financial markets these days is the highly anticipated and wildly sensationalized initial public offering of social networking powerhouse Facebook (FB). Assuming one can remove him or herself from the largely media-driven hype and perform due diligence by looking at the facts, the obvious question to consider while standing in the blast radius of this IPO extravaganza, is simply: What is a share of Facebook really worth?
Since the company announced its intent to go public several months ago, management has been constantly amending its original S-1 registration filing with the Securities Exchange Commission (SEC), which includes its IPO prospectus. The most recent amendment has noted that the company’s ticker will be FB and the equity will trade on the NASDAQ. In addition, Facebook intends to issue 421 million shares of Class A common stock, the holders of which, coupled with preexisting holders of that class, will bring the total number of outstanding Class A shares to 636 million. Notably, the number of shares being sold by private owners has been rising over the past several weeks, which indicates that private equity and venture capital players appear to be increasing their efforts to “cash out”. This is not uncommon, but given all the hype surrounding this particular offering, and the speculation that it is considerably overvalued, the number of shares hitting the market could prove overwhelming to investors.
Collectively, Class A shareholders will only have roughly 4.5% of the voting power following the IPO. The other 95.5% of the voting power will be controlled by Class B holders, the largest of which will be co-founder and CEO Mark Zuckerberg, who will retain 55.8% of the voting rights. There will be 1.5 billion Class B shares outstanding after the IPO, which ought to bring the total number of shares outstanding to approximately 2.2 billion, which includes about 63 million overallotment shares as the offering has been reported oversubscribed for several days. Based on the expected public offering price range of $34 to $38 a share, the sale is likely to generate as much as $16 billion and the expected common market capitalization would be between roughly $75 billion and $84 billion (excludes restricted shares and options included in equity compensation plans that would make the valuation as high as $110 billion).
This would make Facebook’s the largest technology IPO in history, and the second largest public offering recorded in the United States, behind Visa, Inc. (V) and surpassing companies like General Motors (GM) and AT&T Wireless (T - Free AT&T Stock Report). Moreover, some contend that Facebook is already poised to top United Parcel Service (UPS) as the most valuable company, by market capitalization, to go public in the United States. However, unlike the aforementioned companies that have tangible services and assets that generate reasonably predictable streams of revenue, at present, Facebook’s bread and butter are advertising dollars and, to a much lesser extent, fees generated from digital services/products sold through its network platform. These ad revenues, as well as those from digital services, are being propelled by the currently accelerating global popularity of the unrivaled leader in social networking.
Based on its considerable growth rate of monthly active users, which rose 33% to 901 million versus the prior year (as of 3/31/2012), this prospect ought to be an enticing motivator for advertisers and may well justify the roughly 45% year-to-year increase in quarterly revenue to $1.05 billion (3/31/2012). The lion’s share of those revenues came from advertising (about 82% in the first quarter). Worthy of note is the fact that the percentage of revenue coming from advertising has been declining over the past three years (98% in 2009, 95% in 2010, and 85% in 2011). This suggests that the company is striving to diversify its revenue base, which is a positive indicator that it is attempting to enhance the sustainability of its growth.
Taking a closer look at the valuation, based on the expected offering price range, the trailing 12-months sales of just above $4 billion, and earnings of about $0.41, the company would be coming out of the gate trading at between 19 to 21 times sales and 83 to 93 times share net (3/31/2012). These figures are not irrational in the tech world. In fact, another Internet networking outfit that recently went public, LinkedIn Corp. (LNKD), is trading at 930 times trailing 12-months earnings. Too, when Google (GOOG) went public in 2004, its shares were offered at roughly 14 times 2003 sales and between 40 to 50 times earnings. However, LinkedIn offers “premium” hiring and marketing solutions services to its subscribers, for which it charges a fee. Moreover, Google is generating sales and profits that are roughly 10 times those of Facebook, which indicates that it may be doing a better job of monetizing its services, although the search engine is free for anyone to use. In fact, recent filings indicate that Facebook’s revenue growth is decelerating and its year-to-year earnings actually fell in the recently ended March period.
That said, although Facebook is expected to generate stellar growth over the next few years, based on its prospects in mobile advertising and e-commerce, the concern is that it would have to sustain unprecedented growth rates simply to justify its opening price. Moreover, there have been rumors that advertisers may try to press the company’s management to find more “effective” methods of reaching potential customers/consumers and perhaps attempting to monetize its vast resources of personal data, which it collects from its users. Thus far, Facebook’s user-centric approach has been highly averse to any overly invasive advertising strategies or commoditizing its user information. This does not seem to be sitting well with the big ticket advertisers, some of which have contributed to the lofty valuation that Facebook has garnered. At present, “click-through-rates” on Facebook have been quoted well below the industry average and the revenue it generates from each of its users is only about $5 a year. Hence, many advertisers remain unconvinced that money spent on advertising with Facebook is likely to lead to a sale. This suggests that simple banner ads will not be enough to satisfy those who are putting up the big bucks behind this IPO.
This has been demonstrated by General Motors’ recent decision to dissolve its Facebook advertising budget. Although GM’s commitment to the social networking site was a mere $10 million at the time, the carmaker is one of the top-five ad spenders in the nation. This move echoes a broadening sentiment that could prove increasingly detrimental. It is unclear how long management can continue to defend its users against the demands of advertisers. And even more uncertain is how users, who have grown accustomed to the completely free Facebook they know and admire, may react to any corporatization or the notion that the company has “sold out”.
All told, although the recent inclusion of E*Trade Financial (ETFC) and TD Ameritrade (AMTD) to the roster of underwriters may appear to have leveled the playing field a bit on this high profile offering, which is being spearheaded by the usual major league all stars, including point company Morgan Stanley (MS), as well as JPMorgan Chase (JPM - Free JPMorgan Stock Report) and Goldman Sachs (GS), this is still a very exclusive party. Thus, the message has been made clear that the little guy or gal need not apply, as most, if not all of these companies have set the bar very high, reserving their allotments for only the largest and most loyal clientele. However, this may be to the benefit of the smaller retail investor. In fact, it is possible that once the smoke clears and the frenzy subsides, the challenges that this company faces will begin to be reflected in the stock price and by the potential losses to be incurred, should the hype driving this IPO start to deflate. Then, the average users who helped Facebook achieve its grandeur may be thankful they were shut out of what may emerge to be one of the most hotly anticipated and publicized investment fads in financial market history.
At the time that this article was written, the author had no positions in any of the companies mentioned.