Amidst all the uncertainty this week regarding the European economic situation in the aftermath of the sovereign debt crises that have plagued the continent, one gem emerges as perhaps the most anticipated initial public offering in U.S. equity markets in the last decade. Facebook, Inc. (FB), the seemingly ubiquitous social networking giant started in a Kirkland House dorm room at Harvard University, is going public.
This is old news - anyone who hasn't heard of this week's IPO probably lives under a rock. However, despite the intense media scrutiny, bullish sentiments and criticism, there remains a great deal of material information left un-analyzed in the S-1 registration paperwork filed with the U.S. Securities and Exchange Commission by David Ebersman, Facebook's CFO.
The basic information on the upcoming IPO has been thoroughly disseminated - equity shares of the company will trade under the ticker "FB" on the tech-heavy Nasdaq index. New York bulge-bracket investment banks Morgan Stanley (MS), JPMorgan (JPM) and Goldman Sachs (GS) will be the primary underwriters; 85% of FB's revenue came from advertising in 2011; etc. But for a company founded in 2004 with 3,200 employees - compared to Google's (GOOG) 24,000-plus, Apple's (AAPL) 20,000-plus, Groupon's (GRPN) 10,000 and Microsoft's (MSFT) 85,000-plus - Facebook and its innovative, powerfully centralized management have changed our world and the way individuals interact in the digital age. From a business standpoint, the company has the potential to be the best thing to hit the marketing world since the Internet itself.
Many critics contend that at the height of a potential tech bubble with P/E ratios nearing 1999 levels (see AMZN), this is the optimal time for Facebook to take advantage of irrational consumers and retail investors to raise as much capital as possible from this event. Indeed, the company this week raised its IPO range from $28-$35/share to $34-$38/share, and could probably comfortably raise it again before the offering takes place given the extent to which perceived demand outweighs supply.
But Facebook more than other companies may actually have the substance to back up such optimism. Many of these naysayers take a look at the fact that advertising is such a substantive portion of revenue, for instance, and claim that sustained revenue growth is too unpredictable to make this a good investment.
Zynga (ZNGA), for instance, comprises 12% of Facebook's revenue stream. However, what these critics fail to take into account is the year-over-year trends of such metrics. The percentage of revenue derived from advertising for Facebook, for instance, was at a whopping 98% in 2009, and fell to 95% in 2010 before dramatically decreasing to last year's bandied-about 85% figure. Cash on hand for the company, moreover, has been comfortably increasing from $305 million in 2008 to over $3.9 billion in 2011. This is what enabled Mr. Zuckerberg to make such bold moves as purchasing Instagram for a cool $1 billion earlier this spring.
Though this deal may now be subject to government review, delaying the process, Facebook's ability to make such decisive moves points to what I see as a confident managerial attitude. Critics, on the other hand, would claim youthful immaturity - on the part of a talented young CEO with the professionalism and philanthropic spirit of those much more experienced. I don't buy this - Mark Zuckerberg, though maybe not America's next top high-fashion model, knows what he is doing, and is doing more than he'll be paid to do. More importantly, he surrounds himself with qualified individuals who most certainly know what they are doing.
Regardless, Facebook is more than one man (even a man who will control, after the IPO, more than 55% of voting shares). Revenue growth and expense reduction possibilities abound, though, and the growth in revenue from $777 million in 2009 to $3.71 billion in 2011 - creating net profit of $1 billion in 2011 - are compelling. With almost 1 billion users around the globe, and tremendous growth potential after overcoming regulatory hurdles in the Chinese market, Facebook's profit potential is immense. The Harvard-social-scene start-up has become a veritable mint. Thus, the implied IPO valuation of tens of billions of dollars should not be dismissed. Discounted cash flow models with different assumptions yield implied prices per share in the IPO pricing range. Facebook will not only remain a cash cow for years following this week's events, but will likely capitalize upon its acquisitions and human capital to run an even more efficient money-making machine.
At the end of the day, the success of FB - just as with any other publicly traded equity - will come down to its key metrics, ability to generate sustained free cash flows, and adaptive advertising power. All indicators point to the company's ability to do this, at least in the medium term. Where the technology and social media world will be in three years, nobody can tell. This week, though, if you can get your hands on Facebook shares at near-offering levels, there may be no wiser investment.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FB over the next 72 hours.