Facebook: Is it worth it?

The books were closed early on the flotation of the social network giant, which is now valued at up to $104bn. Stephen Foley examines whether this is a wise investment – or whether the buyers have gone mad

Yes

Thirty-three banks can't be wrong. The huge syndicate of finance houses underwriting the Facebook share sale were closing the books early yesterday, happy that they had already found more than enough buyers. So many, in fact, that the range within which the price of Facebook shares will be is now $34 to $38, up from $28 to $35 and valuing the company at up to $104bn (£65bn). The final number is slated to be decided tomorrow night, with share trading to start on Friday. Not for these underwriters, led by Morgan Stanley, any last-minute scramble to find investors. On the contrary, wannabe Facebook shareholders actually queued round the block when founder Mark Zuckerberg came to New York to tout his wares.

So, to the question of the hour – is it worth it? The literal answer is yes, according to the law of supply and demand. To the other question – are these buyers insane? – it depends who you ask. Certainly you need to look beyond superficial metrics like multiples of earnings, or of earnings growth, or of revenues in order to justify the valuation of a company whose business model is still in its relative infancy. It's about the growth potential.

Facebook's bottom line profit last year was $1bn, but that was a 65 per cent rise on 2010, showing how fast the company is growing. Revenues are racing even faster ahead: last year's $3.7bn figure was up 88 per cent on 2010. More firms began experimenting with ads on the social network and Facebook took a cut of the increasing number of "virtual goods" sold to players of Zynga games like FarmVille and CityVille.

Bulls of Facebook, and Facebook itself, in a glitzy sales video posted online before it began its investor roadshow, say the company is just getting started. In March, it unveiled a whole new set of ways for advertisers to get access to the network's 900 million users, including "sponsored stories" which will show up in users' news feeds as if they were posts from friends.

The company's prospectus details numerous other growth opportunities, including the potential for a move into China. The site could also evolve into a market place for more than just virtual sheep and pigs, and take a cut of sales of music, perhaps. Its recent engineering focus has been on persuading users to spend more time within the site, listening to music or reading news articles without having to leave Facebook.

This, according to an analysis by CoRise, the merchant bank, is the basis for believing Facebook could be worth not just $100bn, but several times that. The float price would value each Facebook user at a little over $100, but they could easily bring in many times that in income for the network over time.

Think of Facebook as the phone network, says the report's author Robert Peck. "Regardless of the ways in which social networks are currently monetised (or not), the true and lasting value of these is in their user community. Over time, the market will monetise this in ways that we may not currently contemplate."

No

Metrics matter, according to the investors who have decided to sit out Facebook's flotation. So do risks. At $104bn, the top of the proposed price range, Facebook will be valued at a little over half the current market capitalisation of Google, the search engine whose public share offering in 2004 was the last time a flotation generated a similar frenzy. Google, though, had 10 times the revenues of Facebook last year. It had 10 times the net income of Facebook. Should Facebook be valued on revenue and earnings multiples five times that of Google, whose business model is well established?

Where Facebook bulls point to phenomenal growth opportunities, many as yet unimagined, the bears point to phenomenal risks, many of which are all too imaginable. You don't need to have a long memory to remember that MySpace and Friendster were once dominant in social networking, only to be usurped by Mark Zuckerberg's start-up. Technology is evolving at an unprecedented pace, and threats can emerge at lightning speed from apps on smartphones, where Facebook does not have as strong a grip on websurfers' attention. Arguably the biggest motivation for Facebook buying Instagram for $1bn last month was the threat of the little photo sharing app evolving into a rival social network for mobile phones. This week, Apple said it would allow users of its iCloud to start uploading and tagging photos, moving the technology behemoth nearer to outright competition with Facebook.

A new survey hints Facebook users might be more fickle than their addiction to the site suggests. In an Associated Press-CNBC poll, more adult Americans declared Facebook to be a fad than predicted it had staying power (46 per cent to 43 per cent).

Fully 23 pages of the company's prospectus are given over to risk factors, one of which is the dominance of Mr Zuckerberg himself. Because new shareholders will get a class of stock with fewer rights, and because his early investors delegated power to him, he controls over 50 per cent of the votes despite having less than 28 per cent of the company. He says that gives him the ability to move fast and insulate himself from the short-termism of Wall Street; corporate governance campaigners say it will make it impossible for outside shareholders to tame him if he loses his touch.

But probably the biggest discordant note is the financial results. The 2011 results revealed in the prospectus, and for the first quarter of this year, are below what industry analysts had been expecting, as advertising has proved less lucrative than at first thought, according to eMarketer, the research firm which has lowered its growth forecasts as a result. Revenue growth will slow to 64 per cent this year from 88 per cent last, the third straight year of slowing, says eMarketer's Debra Aho Williamson.

The slowdown does not appear to have dampened the frenzy over Facebook shares, though, and that might be the biggest warning sign of all.

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