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Facebook, Many Questions Unanswered?

With the much waited IPO approaching, many brokers, banks and financial advisors have been questioned by investors about the prospects of investing in Facebook. With a S-1 already available some information can be publicly be shared.

Revenues 2011

Facebook revenues in 2011 were USD 3.7 bln a +88% growth rate as compared to 2010 with the number of monthly active users growing 40% to 850 million as of December 2011 from December 2010. Operating income came at USD 1.76 bln, +70% over 2010.

Revenue streams

Facebook posted two main revenues streams on its prospects, the most important being advertising through their site but increasing faster and already representing 17% of total revenues, the "payments" division. Payments would be Facebook's subscribers that can effectively have virtual Facebook accounts in order to purchase virtual or digital products through Internet (games, virtual gifts, etc). To take the prospect example, in a social game such as FarmVille, a subscriber could buy machinery for his virtual farm through a Facebook account previously feed by the subscriber. Facebook would take some fee on this sale when passing through the results to the game developer.

Capitalization

There will be 2 classes of shares with different voting rights, class B having 10 voting rights per share while class A with 1 vote per share. According to some estimates, the IPO will generate some USD 5 bln of resources, at USD 40 per share; the first estimates value Facebook at near USD 100 bln in the market value. CEO and founder Mr Zuckerberg will have 57% share control.

Balance Sheet

At the end of 2011, Facebook registered a USD 4.9 bln book value and cash balance plus investments were USD 3.9 bln with no debt.

Some first thoughts…

Valuation

If the IPO is priced at USD 40 per share, the company will start with a market value nearing USD 100 bln, which represents roughly 27x trailing 12 months sales ratio or around 100x trailing 12 months earnings ratio. Needless to say that these ratios are much higher than currently public companies in the Internet sector such as eBay (trailing PE of 19x and price-to-sales at 3.8x) or Google (trailing PE of 20x, price-to-sales at 6.7x). The first question that comes to mind for an investor willing to put money into Facebook would be:

How long can Facebook continue to run at these growth rates in order to justify the hefty premium observed in this IPO according to these data? To answer this question we have already some numbers: monthly active users (MAU) reached 845 million worldwide at the end of December 2011; which is already more than 10% of earth's population. We do not know yet if subscriber's growth rate has a significant impact or correlation with revenues growth rate, but running at +40% currently, MAU would reach total earth's population in less than 10 years. So the real question investor should ask would be: "Can Facebook sales continue to grow even if MAU growth stalls?" The payments division could be a new growth driver non-related to advertisement to support growth in the future. Is there any other business that could arise in the future to monetize such a 845 million rich subscriber base?

Future prospects

Is Facebook's business model sustainable for the long term? Facebook evolves in a very rapid changing world. Looking back at some internet successes of the past we have seen that landscape in tech generally can change rapidly. Facebook is being the first good example of that by making MySpace irrelevant in only few years in the social network space. The same happened to Yahoo! in the search field a few years ago. So will Facebook be the social media of the future and how can they monetize that to justify such high multiples?

Company's shareholders.

Facebook is coming to the market at a much more mature stage than it closest peers from internet in the past. The company do not really need money as mentioned above, and they are selling only 5% to 10% of the company to the public. That said, we will be in a situation where we will have a minority amount of individuals (Mr Zuckerberg and other private equity owners) controlling a significant major stake of the company and following this IPO, we will have a incredible amount on individuals chasing only 5% or so of the shares available. This situation might cause some scarcity effect following the IPO and make them even more expensive then it already appears, when looking at the aforementioned valuation ratios.

Institutional investors

With only 5% floating, the question remains if Facebook will be interesting for big institutional fund managers at these prices? And what will private equity owners, having already a big profit following the IPO do with their shares, or part of it, after the end of the lock up period? What will Mr Zuckerberg do himself with its 57% stake or part of it? How will hedge funds react to such a hyped IPO?

Final Conclusion

There are still many questions that are open and can't be answered right now. Those questions can have a significant impact on the share price following the IPO.

Because the offering price and the exact number of shares offered are unknown, it's impossible to have an opinion. But looking at the hype and the high levels of valuation, savvy investors should take a cautious approach when investing money in Facebook following the IPO.

This IPO could be marginally favorable to other internet names linked to advertising and internet, because the valuation gap between them and Facebook (according to recent published numbers) will make them look like a bargain.

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