Facebook: To Like Or Not To Like?

| About: Facebook (FB)

To like or not to like Facebook (NASDAQ:FB)? That is the question facing potential investors in the social media company's upcoming initial public offering.

In the company's IPO filing, CEO Marc Zuckerberg touts Facebook's mission as that of making the world more open and connected, and compares Facebook with transformative technologies such as television and the printing press that changed the way people receive information.

The difference is that Facebook is more of a social medium than a transformative technology, and one that doesn't operate in a space with high barriers to entry. While the opportunity does exist for online mediums such as Facebook that connect people to others, there are also others that could seize on this opportunity, as predecessors in this space such as MySpace and Friendster have learned.

Facebook touts that as many as 901 million users worldwide actively use Facebook monthly, up from 197 million in March 2009, while as many as 526 million people actively use the social media site on a daily basis, a leap forward from the site's 92 million "daily active users" in March 2009.

Considering that globally more than two billion people use the Internet, this represents a market penetration of higher than 40% for Facebook.

Based on this advantage, the company is looking to raise as much as $13.5 billion through the issuance of more than 337 million shares that the company expects to price in the range of $28 to $35 per share.

This offering will also set the value of Facebook at as much as $95 billion, based on its shares outstanding after the IPO. In comparison, the Google (NASDAQ:GOOG) IPO set a value of $23 billion on that company.

While Google shares have justified their IPO pricing, with the company now valued at about $200 billion, it remains to be seen whether Facebook shares will get on such a growth trajectory, given the risks the company faces.

For one, advertisers are not quite clear about the return that they are getting on their advertising dollars from their Facebook campaigns. The company derives the bulk of its revenues from advertisers who find the site a convenient way to target different groups that use Facebook, such as single men in the 25 to 35 age group who live in Oklahoma and are college graduates. For the first quarter of 2012, income from such advertising made up as much as 82% of Facebook's revenue.

While Facebook has developed analytical tools to address such concerns, they don't fully address these concerns. Advertisers have a better idea about the return they get by advertising on competing avenues for advertiser dollars, such as Google and Yahoo (NASDAQ:YHOO).

Moreover, more than half of Facebook's "monthly active users" access the social media site through mobile avenues. Facebook does not generate any significant revenue from mobile access and if people start to increasingly substitute mobile access for access to Facebook via a personal computer, it remains to be seen if Facebook will be able to convert the mobile access into revenue for the company, the same way it has been able to monetize users' activity so far.

Other sources of revenue for Facebook come from advertisements related to applications and websites that integrate with the social media site, as well as from fees related to sales of virtual goods to Facebook users by companies such as Zynga (NASDAQ:ZNGA), using Facebook's payment system.

In fact, Facebook generates a good part of its revenue from Zynga, and that's another risk to watch for. Zynga accounted for as much as 15% of Facebook's revenue in the first quarter of 2012. If Zynga were to shift its games to another avenue, or if Facebook's relationship with Zynga were impaired for some reason, that could have an adverse impact on Facebook's revenues.

As well, Facebook admits that it expects its rates of growth to slow down over time. The company's revenue growth has tapered off to 45% from the first quarter of 2011 to the first quarter of 2012, after growing 154% from 2009 to 2010.

Moreover, the share of its revenues that goes towards the company's income from operations has dwindled from 47% in the first quarter of 2010 to 36% in the first quarter of 2012, as Facebook's costs have eaten away faster at the company's revenues.

Facebook expects that growth in its user base, and revenue growth, will slow as its user base increases with greater market penetration.

While the company generated 52% of its average revenue per user in the United States and Canada in 2011, down from 58% in 2010, Facebook is now seeing faster user growth in Asia and other areas where it generates lower average revenue per user. Facebook expects this trend to continue.

Another challenge is that outside North America Facebook sees competition from a variety of social media networks such as Orkut, in Brazil and India, and Cyworld, in Korea.

There are also issues relating to how Facebook handles privacy considering that it has access to the information that its users share with each other.

For investors, the best course may well be to buy into the Facebook IPO not with the idea of holding for the long-term but with the anticipation of selling at a pop over the IPO price. At least one Wall Street analyst is expecting that demand for the shares will exceed supply causing them to trade up.

And if you are a Facebook user, investing in the IPO could be a way for you to monetize the free information you provide that creates Facebook's business model in the first place.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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