Thursday, February 2, 2012

Facebook Files For IPO: What the S-1 Reveals

Some things of interest from yesterday's Facebook S-1 filing:

- Facebook's 2011 revenue was $ 3.7 billion. Revenue grew 88% year over year and is up nearly five fold since 2009.
- Facebook has $ 3.9 billion in cash.
- Net profit was $ 1 billion, a 27% net margin. However, free cash flow was less than half that amount at $ 470 million.
- 845 million active users, up nearly 40% from the previous year.
- In 2009, 98% of its revenue came from advertising.
- In 2011, revenue from advertising was down to 85%. The other 15% is, for the most part, driven by in-app purchases from games like Farmville (12% of revenue comes from Zynga).
- Facebook's revenue last year is slightly higher than Google's was the year it went public ($ 3.7 billion compared to $ 3.2 billion). Facebook's $ 1 billion of net income is more than the $ 400 million Google earned in 2004.
- Mark Zuckerberg owns a little more than 28% of the company. That means his stake is likely to be worth $ 25 billion or so. He'll be fine.

According to this article, revenue growth is expected to slow substantially over the next couple of years:

...Facebook ad sales worldwide are slackening. They grew 104% in 2011 but are expected to climb just 52% to $5.8 billion this year and only 21% to $7 billion next year, according to eMarketer.

The same article goes on to point out that the value of Facebook's ad inventory fares poorly when compared to the industry average and especially to Google:

"Facebook is not as effective as paid search (on Google, Yahoo and Microsoft)," says Dave Beltramini, director of online strategy for G5, a marketing services firm. "The intent of consumers on Google is more about shopping. On Facebook, people are more social, looking at photos of their friends' kids."

The article points out that on CPM (cost per thousand impressions), a key pricing metric when it comes to valuing ad inventory, Facebook's is at just 22 cents compared to Google's several dollars. We'll have to see how that evolves over time.

Facebook is looking to raise around $ 5 billion in this offering but, of course, that number could change between now and when the IPO happens. From the S-1:

We intend to use the net proceeds to us from our initial public offering for working capital and other general corporate purposes; however we do not have any specific uses of the net proceeds planned.

So whatever they do end up raising should be a nice addition to the $ 3.9 billion of cash they already have on their balance sheet.

Most companies aren't a large cap stock the day it goes public but, at a $ 75-100 billion expected valuation (and, of course, a 75 to 100x P/E), it looks like Facebook's going to be an exception. Facebook will have nearly 3-4x the market valuation that Google had when it went public in 2004.

Now, I don't doubt the company could become worth that kind of money or even much more some day.

Whether Facebook is actually worth that much YET is another question.

Profitability will need to grow substantially and prove durable to even justify the expected initial valuation (never mind actually make some money for an investor).

My point is this. Paying a substantial premium to the current valuation with the hope that an investment may actually be intrinsically worth it someday isn't exactly the road to riches. I mean, who puts capital at risk for the privilege of eventually getting it back? So, even though Facebook may someday justify its lofty valuation (and even then some) over time, it won't necessarily provide great risk-adjusted returns compared to alternatives.

It's not that returns will necessarily end up being negative.

It's that returns relative to the risk taken will be inadequate. The direct result of paying an excessively high initial price.

In other words, getting something "right" yet being compensated little for it. Now, Facebook could sure end up being, once again, an exception. It is quite a franchise. Yet, most of the time, pay a price that represents a possible future value instead of a discount to current value and odds are long-term results will be subpar or worse.*

Facebook is clearly worth a lot of money. It's already a sound business that has a good probability of increasing in value over time. Considering the high profile of the company, it's not hard to imagine it starting out as an expensive stock and proceeding to become even more so in a speculative frenzy.

That may make it an interesting trade for those who do that sort of thing but, unless the valuation drops far below what is expected, it's going to be a tough thing to truly invest in. There's nothing wrong with not owning shares of even a very good business if a chance to buy with an appropriate margin of safety isn't available.

Adam

Related posts:
Facebook's IPO: $ 100 Billion Valuation?
Facebook's 1st Half Revenue Doubles to $ 1.6 Billion
Is Facebook Worth $ 100 Billion?
Technology Stocks

* Near its current valuation, the risk of negative returns is uncomfortably high if things go a bit less well than expected. Having said that, sustained high return on capital over 2 or 3 decades eventually does make an initially expensive looking investment make sense. In the very long run, results tend to be drawn like a magnet toward the return on capital earned by the business. I don't think I have any capacity to even roughly estimate Facebook's return on capital or its sustainability over such a long time horizon. Others may be able to or, at least, think that they can.
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