Facebook IPO: Boom or Bust?

By Brad Jensen
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Well, here we are, Facebook’s day has finally arrived. Do you have butterflies? Are you checking your favorite finance news sites for minute-by-minute updates? If you’re interested in Facebook’s Initial Public Offering you may be – or you might be on information overload by now. When Facebook stock starts trading on Friday, May 18 under the ticker symbol FB, all eyes will be on the markets.

Rarely has there been this kind of attention on a single IPO in the history of the stock markets. The numbers are huge: a potential $100 billion valuation for a company that many analysts believe is unwarranted – the current revenue numbers just don’t seem to add up and its unique business model isn’t financially proven. It’s now expected that the initial share price will be in the $34–38 range, and many think it will go higher from there in the initial hours of trading. “Irrational exuberance”? Perhaps, but then again, maybe not.

Other IPOs have made big splashes, but none have been quite like this. Here’s a look at some other recent tech-industry IPOs and how they compare to the Facebook offering.
 

Google

Remember Google’s IPO? It was almost as closely watched as Facebook’s, but the numbers were very different. During its August 2004 debut, Google raised a then-whopping $1.67 billion and garnered a cool $23 billion valuation. Shares opened at $85 but jumped almost immediately to $100 – a previously unheard of leap.

Google's stock closed at $108.31 per share that day. In late 2007, shares rose to the $700 range, and then dropped to the $300 range during the most recent recession, in 2009. Since then, based on solid earnings, constant revenue innovation and market domination, Google's shares have risen steadily to the middle $600s today.


Apple

Apple’s IPO is not exactly recent, but it’s worth including here, as ballast, because its share price has commanded a fair amount of attention in recent months. In early 2009, a share of Apple stock was in the $100 range.

Based on solid financial performance quarter after quarter, it has risen to its all-time high, having flirted with $600 per share a couple of times in recent weeks. There’s a lot to say about Apple as a company, and about its stock. While most view it as strictly a tech company, many others see it as a lifestyle company, and there are many evangelistas who will tell you exactly that. But in the end, financial performance is its own reward.
 

 

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Groupon

Groupon may be the most controversial IPO to come along in quite a while, because very few analysts believe it’s worth much of anything at all. Recent accounting and staffing problems have certainly not helped. It’s also worth noting that Groupon turned down Google’s 2010 offer to purchase the company for $6 billion. Who knows, maybe Google is breathing a sigh of relief on that one.

Groupon raised nearly $1 billion in venture funding that year, and grabbed a valuation of $6.4 billion – but the company used a huge chunk of that money to pay its founders and early investors without doing much to improve the company. Recently, Groupon revealed that it loses about $100 million every quarter. When the company went public, it raised $700 million, giving it a $12 billion valuation at the time. In the intervening six months of trading, the stock has fallen through the floor, punctuated by a recent-quarter plunge to the $10 range – just 30 percent of its opening-day price. That’s enough to give any investor a nosebleed.
 

LinkedIn

There were mumbles of a tech-stock bubble when LinkedIn announced that its IPO would happen in May 2011. The eight-year-old company was known as “Facebook for grown-ups” and had just $243 million in revenue for 2010. Despite this, the company decided to sell more than 7 million shares, priced at $35 each, giving it a market value of $3 billion. On its opening day, shares went for more than double that, all the way up to $86, making a lot of giddy employees, to be sure. But then reality set in, and LinkedIn needed to set better market and analyst expectations. It did so by indicating in its guidance that the company expects “slow growth in the future.” That’s investor code for “irrational exuberance”.

It must have worked, because the stock has gone from $60 per share all the way up to its current price of $105, and sentiment remains bullish.
 

What does Facebook have to offer?

There’s plenty of talk out there about current Facebook revenue, and more important, its current losses. But what Facebook really has is a ton of really deep Big Data. Its 850 million active users generate 2.7 billion comments and “likes” per month. Think about that for a moment – we’re all telling Facebook exactly what we like and what we care about. They know more about us than any other company, arguably even more than what Google knows about us.

Google knows what we search for, and a few other things like that, but Facebook knows who our friends are, how we vote, what we like to eat and the movies we like to see. There’s huge value in that information. Is it $100 billion worth of value? It depends. A $100 billion valuation dwarfs all other IPOs. In fact, it dwarfs all the tech IPOs discussed above, combined. That’s a lot of performance anxiety for Facebook.

A big database is only as good as the value it can produce for those who use it. Facebook is betting that advertisers and businesses will be able to target their best potential customers using its vast data pool. That’s a pretty great value proposition for any business, isn’t it?
 

What are the risks?

None of us likes intrusions on our privacy, and we don't want to think that our personal Facebook activity can be used to target us for services. So, Facebook's major conundrum is finding a way to bring value to paying advertisers in a way that doesn’t alienate its main asset – you and me. Facebook hasn’t figured out how to do that all the way yet, but the clues in the pre-IPO SEC filings show that the company is serious about figuring out how to solve that Rubik’s cube.

Another risk is the cost involved in setting up and maintaining the massive infrastructure to support the gargantuan bandwidth consumed by its user base. Facebook has made a huge investment in SSD (solid state drive) technology for its faster access time and lower power consumption and cooling costs. This sort of technical awareness will be critical in the coming years.

Facebook will also have to find a way to increase the time its users spend on the site. That means keeping third-party developers interested and happy. Facebook has garnered a bit of a black eye recently in this area. There is a perceived Facebook bias toward Zynga (makers of FarmVille, and many other “-ville” games on Facebook), and many developers on the outside feel that they’re not being supported with resources or visibility. Zynga accounted for 12 percent of Facebook's revenue in 2011, and 11 percent of the company's sales in the first quarter of 2012. Facebook may be missing a key opportunity by not paying attention to the rest of its developer base. The risk is staleness.

Facebook also has to grow up some. Let’s face it: Zuckerberg just turned 28. He’s a kid, with a monster fish on the line. He does kid stuff; he was totally fine with blowing off some of his appearances on the IPO road show circuit, and he's known to make pretty rash decisions. Think Instagram.

"The Wall Street Journal" reported that Facebook’s board of directors was “told,” not consulted, about the Instagram purchase for $1 billion. The deal took place over a weekend, and that’s a pretty heady move for a company trying to position itself as a value blue-chip stock only a couple of weeks ahead of an IPO of this stature. That kind of decision making gets trickier in the structured world of multi-billion-dollar public corporations. The board is the last line of defense for the minority shareholders, of which there will soon be millions more.
 

Conclusion

Obviously, there are upsides and downsides to Facebook’s offering, and only time will tell if the financial markets have the stomach for the frenzied ride. In the end, Facebook has to show financial performance and an ability to mitigate risks, both known and new. Rational decision making and forward-thinking leadership will rule the day. If Facebook shows competence in these areas, we may just be looking at the beginning of a completely new online advertising and revenue paradigm. Or, Facebook could be the next Groupon.

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