What about Facebook's IPO?

You would have to be living on another planet if you haven’t heard about the Facebook IPO by now. Deemed as one of the largest public offerings in the world, it has been a roller-coaster ride for what was once a college social network.

But while many amongst us in the Singapore digital fraternity had been looking forward to their IPO with baited breath, and at 100B dollars were expecting it to be larger than the Google IPO in 2004, there are some complications ahead before the deal is done.

In recent days there have been news reports of Yahoo filing a suit against Facebook for infringing numerous patents. And then there’s the SEC crackdown on the secondary marketplace for pre-IPO stock. All of this has cast an ugly shadow on what should have been Facebook’s coming out party and is sure to dampen the price expectations of the IPO.

But it’s not time to throw away the balloons just yet. Although Yahoo’s claims are not groundless, at best they stand to gain a $5B chunk of the Facebook pie. And with the pre-IPO market being monitored closely by the SEC, price expectations may finally normalize to reasonable levels.
So really, the question once again comes down to – is Facebook underpriced or over-valued?

Pricing - you get what you pay for:
These days, everyone and their aunt are on Facebook. Just take the mass appeal of the Kony 2012 campaign on Facebook as an example of how pervasive it is. The video went viral within minutes because of the social network’s reach – and in a fortnight has garnered 80 million views. Developed countries like Singapore are seeing Facebook penetration rates beyond 55%, and that’s happened in a relatively short period of time. Facebook claims over 800M in monthly active users world-wide. We expect this number to rise to a billion before the year ends. Imagine 1 billion people spending long hours each day exploring, connecting, and if Facebook will have their way - spending real money on a platform they have complete control over.

And Facebook wants us to believe that all this is worth $100B in valuation. Is it?

Google - The elephant in the room
We often hear Facebook being compared to Google, and rightly so I should imagine. If you look at the two web wonders, they're both really in the advertising business. Google sells "search intent" whereas Facebook sells demographics and social connections to brands in order to make copious sums of money.

Let's recall the now legendary Google IPO from 2004 (famous for its founders' "Do no Evil" maxim). When Google launched its IPO - it was the largest Internet IPO valued at $23B. Google managed that because they were generating profits off the back of revenues of $4B. That’s a Price-to-Sales ratio of 8.7.

Facebook on the other hand will launch at a Price-to-Sales ratio of 26 based on revenues of $3.8B. This is more than Google's PSR of 8.7 and 26 times more than the average large sized IPO. Are we really expected to take the Facebook valuation seriously with numbers like these?

Sales and Revenue
Today at a market cap of $200B, Google generates over $9B in profits from revenues of just about $40B. If Facebook were to be valued at $100B, we'd expect it do at least half as much revenue of what Google is pulling in today. But at this point, Facebook barely scrapes $5B in annual revenues. That’s a long way off to be reasonably comparing Facebook to Google.
So if you play it by the numbers above - then Facebook will look like a terrible IPO to put your money into. Can Facebook ever imagine being as big as Google or will it completely dominate Google on the Internet?

The Upside
Now there are some who say Mark Zuckerberg is a smart man and is barely beginning to show his hand. They believe revenues from direct advertising are just the tip of the iceberg for the revenue avalanche they anticipate. And I have to say I'm inclined to believe them. To put things in perspective, Facebook currently makes under $5B in revenues a year. Most of this comes from direct advertising on its site. In 2011, only 11% came from Facebook credits.

To put things in perspective, Facebook currently makes under $5B in revenues a year. Most of this comes from direct advertising on its site. In 2011, only 11% came from Facebook credits.

Facebook Credits
Facebook Credits is the first of the growth strategies that will help Facebook become a giant. Imagine the ability to issue a currency of your own making in an environment that you have complete control over. Facebook Credits is the only means available for applications and companies to bill and charge Facebook users. From virtual goods to social gaming, Facebook applies a 30% processing fees for all transactions, allowing them to cream a healthy margin off the top of every single successful application on the Facebook platform.

Remember Farmville. Its maker Zynga, which incidentally owes its very existence to Facebook, had a $10B valuation when they listed in Dec 2011. And Facebook simply creams off 30% off the top of everyone from Zynga to Disney. Now that’s a sustainable business model and Apple has proven it.

Facebook Places and Deals
And then there are Places and Deals. Imagine Groupon built directly into every single brand's Facebook Page! Today Groupon can drive over $10M in revenue for some retailers in a single day and is worth over $15B. Now imagine the amount of revenue Facebook could drive by enabling every single brand or merchant with time and location sensitive deals on their Facebook Pages. This alone could contribute profits of $5B in a couple of years.

Technology Expertise
This is just the beginning. At the recent IPO filing, Facebook revealed information on technologies and patents it has waiting in the wings. I am sure Mr Zuckerberg still has a good number of tricks up his proverbial sleeve.

The Rest of the World
Although Facebook's growth has just about stagnated in most developed countries, they're having a strong run in the rest of the world.

Take Indonesia for example; which has the 3rd largest number of Facebookers in the world but penetration is still at a low of 17%. In Indonesia, you can sense the excitement amongst brands, both big and small, of Facebook and its power to connect with customers. And cheaper, smarter mobile devices will fuel Facebook's growth in these developing markets for some years to come. 

Crystall Ball Predictions
Although I can see the value of Facebook and experience the excitement it has created for digital industry professionals, I still think a $100B valuation is too high at current revenue and profit numbers. That said - I don't see any reason to believe why Facebook can't be bigger than Google in 5 years. But it can’t afford to be complacent. In the world of Internet startups, you never know what might pop up at the next SXSW.

Charanjit Singh, Digital Director, Construct Digital