Facebook IPO Requires Leap of Faith: Author

AP

It’s the capital markets event of the year.

But anyone wanting to buy stock in Facebook’s imminent initial public offering needs unwavering faith in the vision of Mark Zuckerberg, the social network’s founder.

There’s no doubt that Facebook, like Google before it, is breaking new ground with a potentially hugely influential use of the increasing interconnectedness of the world.

And an IPO that values Facebook at anything near $100 billion – raising more than $10 billion from the sale of new and existing shares – would be notable beyond the pleasing roundness of the numbers.

But there are at least two key articles of faith needed to get there. First is confidence in Zuckerberg’s capacity to keep adding to Facebook’s nearly 1 billion users. Second, and probably more important, is belief in his ability to turn each of those likers, commenters and posters into more and more cash over time.

The scale of the task is clear. Based on the first quarter, Facebook’s revenue per monthly user is on pace to be less than $5 this year, with the net income per user running at a fraction of that. Yet at a $100 billion valuation for the company, the flow of profit needs to be worth the equivalent of $110 or more for each of today’s users.

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That’s why it’s hard to reach that kind of valuation for Facebook – or maybe it should be “Faithbook” – by any down-to-earth valuation method. Reuters Breakingviewsdeveloped a valuation based on the trajectory seven years earlier of Google, another at the time unpredictable play on new uses of technology. Even assuming Facebook manages the same kind of success, we only made it to just above $80 billion – near the low end of the $28 to $35 per share that Zuckerberg’s company is slated to sell for (a figure that could yet go up).

Or consider it this way. Google is now worth about $200 billion. That’s twice the magic $100 billion number that may attach to Facebook. But the Internet search firm reported 10 times as much revenue and 14 times as much profit in the first quarter of this year.

It’s true that Google’s top line growth doesn’t match Facebook’s these days. But Apple’s does. Yet the iPhone maker trades at a market value about 12 times the profit analysts reckon it will make this financial year, according to Thomson Reuters data. Facebook, on the other hand, may go public at a valuation that’s 54 to 68 times this year’s anticipated earnings, Susquehanna Financial Group reckons. That dwarfs the multiple for pretty much any company that’s remotely similar.

Of course, that’s the key to all the hype: the idea that Facebook is simply different. But in important ways, it’s just another company. In some areas, it faces tricky competition, for instance in making money from people using it on mobile devices. In others, it has become so dominant that it could easily run into Microsoft and Google-like antitrust headwinds. And as an investment proposition, there’s the long-term worry that if Zuckerberg doesn’t manage to keep making shareholders richer, his control is such that there will be precious little they can do about it.

Grouches of this kind look unlikely to derail the Facebook juggernaut as it steams towards its debut on the Nasdaq market. The excitement may well send the stock well above the actual IPOprice when it starts trading. It’s after the hype has worn off, when the faithful may have reason to ask questions, that skeptical investors might want to take a fresh look.

Richard Beales is a Reuters Breakingviews editor and a contributor to the e-book “Facebook: A ‘Like’ Story – Why investors shouldn’t fall in love” by Breakingviews columnists, published on May 8.