Earlier this month I was very enthusiastic about Facebook's (FB) IPO, as at the low end of its planned offering price of $28, its market cap could be around $80 billion. This price, albeit expensive, can bring in above-market return in five years.
However, with more information coming in, things have changed. First, Facebook's offering price is more likely to be $38, valuing the company at $104 billion. The price could go even higher after the IPO debut in the open market. Second, Facebook's revenue growth in the most recent quarter was far from exciting at 37%. This has gradually become a sucker's bet.
Here is why: Facebook's core business is advertising. Maybe not like in Google's (GOOG) case, where advertising accounts for 97% of the revenue, but Facebook will be a majority advertising business. So in order to gauge the long-term return, I can start with the total size of the global advertising market. I will also benchmark Facebook against Google.
Global advertising spending is largely a zero-sum game. The total size of the pie grows slowly (~5% pace) in general and sometimes declines with the economy. Global advertising expense can be slotted into the following categories: television, Internet (search, display, video, and mobile), newspapers, magazines, radio, cinema and out-of-home (traditional and digital). Last year, 45% of the growth in ad spending came from four major emerging economies: Brazil, Russia, India, and China. The global total is approximately $425-$450 billion in 2011-12.
Out of the major media categories, television is still king, with $175 billion, or 41%, of global market share. Internet, the part most relevant to Facebook, is projected to grow at a fairly slow pace of 11.2%, to $87 billion. Out of this Google takes nearly $40 billion. Within the Internet category, Facebook's revenue is $3.7 billion. Since this is largely a zero-sum game, in order to have above-average growth, Facebook has to grab a larger share of the market at someone else's expense. Facebook's focal point is likely to be display, video, and mobile advertising. In each category, it faces strong competition from Google, weaker competition from Yahoo (YHOO), and possibly some friendly fire competition from Microsoft (MSFT).
During the most recent quarter, Facebook was growing at a meager pace of 37%. General Motors' (GM) decision to "unlike" Facebook also cast some doubts about the latter's advertising effectiveness. At this pace, how long would it take Facebook to reach $20 billion in revenue (50% of Google's, since its market cap will be slightly over 50% of Google's)? A little over five years. That is, it will take five years for Facebook to just catch up with the valuation it will have after its IPO. That makes buying Facebook's IPO extraordinarily risky.
Other than the Internet, can Facebook gain from the other media categories?
- TV, Radio, Cinema
It is highly unlikely that major TV or movie producers would let Facebook use their content without getting handsome financial returns. They could move some advertising spending from these venues to Facebook.
- Outdoor
This is not Facebook's business. With digital displays, the outdoor market may actually take market share from Facebook.
- Magazines, Newspapers
Both are in decline, but since Facebook (like Google) does not have its own high-quality content, it likely would only benefit marginally from display advertising switched from print to online.
Can Facebook expand into China and significantly boost its growing pace? That's certainly possible. But for now, the IPO stock price has just become too risky for investors.
Disclosure: I am long GM.
