Yesterday (1/30) I spoke with Bloomberg West's Emily Chang on what I'll be looking for in Facebook's S-1 filing, which is expected out soon. I discussed some of the parallels between Facebook's S-1 and Zynga's (ZNGA) S-1 (Zynga being the first multi-billion dollar company built almost entirely on Facebook's platform), and between Facebook's IPO and Google's (GOOG) IPO. You can view that interview here.
Google is the best comparison for Facebook for a number of reasons, including:
- Both companies developed disruptive 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.
However, 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. Based on our estimates and the 10x forward P/S multiple we believe 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.
Some advantages to Facebook's model include:
- More diversified revenue base. Google still generates +95% of revenues from advertising, while we expect Facebook generated +10% of 4Q11 revenues from Facebook Credits (E-Commerce) lines, including the sale of virtual goods in social games made by partners like Zynga, Disney's (DIS) Playdom, CrowdStar, RockYou and Germany's Wooga (short for World of Gaming). We believe that Facebook has many more "levers to pull" in E-Commerce and that investors will pay a premium for this more diversified base of business.
- Higher margins. We expect that Facebook will show higher EBITDA margins than Google's 40% margin at the time of its IPO. This is partly because the Google revenue number we use in calculating GOOG's margin includes traffic acquisition cost ("TAC"), which Facebook does not have. The absence of TAC for Facebook points to two strengths: 1) higher margins, and 2) the absence of an owned & operated ad network - a potential source of significant future growth if the company does deploy its own social ad network.
- 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.
Now, with no further hesitation...
What to look for in the Facebook S-1:
- Margins. For comparison, Google had approximately 40% EBITDA margins in 2004, the year of its IPO. We believe Facebook's margins are at or above this level. We will also be looking at OCF and FCF margins as a percentage of revenue. 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, we estimate that Facebook generates +10% of revenues in 4Q from E-Commerce lines, which fall under Facebook Credits, the company's PayPal-like online wallet/payments platform. This diversification is one of several advantages Facebook has over Google and other Internet advertising peers, and is part of the reason we believe a 10x forward P/S multiple is appropriate. Any and all information that investors can glean about Facebook Credits from the S-1 will be valuable.
- Growth. We expect Y/Y revenue growth for the most recent period to come in between 75-100% Y/Y, and we believe this rate of growth is necessary to justify the 10x P/S and 25-30x EV/EBITDA multiple that we see fit for Facebook based on its unparalleled market position and growth prospects. We believe that growth could slow to 75% or less for a quarter, before re-accelerating due to the early-stage nature of the Credits/E-Commerce businesses.
- International revenues. Other Internet heavyweights like Google and Groupon (GRPN) already generate more than 50% of revenues from outside the U.S. Facebook maintains a leaner team than Google, and we believe it has very large future upside potential for International advertising revenues, besides the upside we see to global E-Commerce revenues.
- 10% customers. Microsoft, Zynga, Groupon and LivingSocial are all large Facebook advertisers. It will be interesting to see which if any among these currently represent 10% or more of Facebook's overall revenue. Facebook may also reveal if there are any other customers who account for more than 10% of advertising revenues, but not more than 10% of overall revenues, as well as what percentage of Facebook Credits revenues come from Zynga.
- Nonfinancial metrics. In each geography where Facebook has active users, we have seen similar trends: rapid growth in the active user count is followed by rapid growth in average time spent on Facebook per user, which is then followed in time by growth in monetization. Active user count and average/total time spent on Facebook are among the key metrics we will be looking for.
- Partnerships, investments. Just as Zynga's S-1 provided information about a 3% equity investment that Google had made in Zynga, Facebook's S-1 could provide more information about Microsoft's investment in and partnership with Facebook, as well as other potentially meaningful third party investments in Facebook and by Facebook in other companies. It never hurts to scan the entire document for all references to partners and competitors, such as Microsoft, Google, Zynga and Twitter. Music/film/media partners are also of interest.
- Patents. Patents are a big part of why Facebook has more of a protective "moat" than Friendster and MySpace before it. Zynga's S-1 for example provided insights into its own key patents, and how pending legislation may impact its ability to defend those patents and associated intellectual property.
- Other growth initiatives. We have identified +10 other potential areas of potential future revenue growth for Facebook, including Social Learning software, online photo processing and others. We believe the S-1 could provide clues regarding other areas where the company is making investments to prepare for future growth.
- The global technology platform. Details of infrastructure investment will also be valuable, to the extent that they are provided in the S-1. While we believe Facebook's platform has the potential to be more scalable and generate more revenue per employee than Google over the medium to longer term due to the amount of "heavy lifting" that is done by Facebook's third party developer partners, the apps and associated resource usage generated by those partners also require Facebook to invest heavily in developing and maintaining a world-class technology infrastructure. This makes capex and technology partnerships more important.
- Size and description of acquisitions. Any additional detail on acquisitions Facebook has done will be helpful, both in terms of understanding how Facebook views its own strategy for growth and of how it looks at acquisition candidates from a valuation standpoint.
Please stay tuned, we will also be providing analysis of Facebook's S-1 once it is filed.