Analysis: Facebook IPO tests easy growth assumptions

Focus to shift from user growth to revenue growth; $100 billion valuation sets high expectations; diversification moves bump into Apple, Google.

February 2, 2012 11:38
3 minute read.
Facebook CEO Mark Zuckerberg

Facebook IPO. (photo credit: Norbert von der Groeben / Reuters)


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SAN FRANCISCO - As Facebook hurtles toward one of the largest initial public offerings in US history, its honeymoon with investors may already be over.

The dorm-room project started by Harvard dropout Mark Zuckerberg, 27, could well become one of the world's most highly valued Internet companies when it sells shares to the public for an expected valuation of as high as $100 billion.

But the relatively carefree days of super-charged user growth may be behind Facebook, analysts say, as the social networking company begins the difficult task of living up to Wall Street's lofty expectations under a public microscope.

Facebook's IPO prospectus, filed with US regulators on Wednesday, revealed a profitable and fast-growing business built upon advertising revenue and online transactions.

But the Silicon Valley company's $3.7 billion in revenue last year was at the low end of analysts' expectations and underscored the wide gulf between its current business and the most optimistic hopes that many investors have riding on it.

"For the valuation that people are going to be paying for this name, they're going to probably be overpaying by a third because of the optimism related to just the name," said Michael Yoshikami, chief executive of YCMNET Advisors, a California-based wealth management firm.

"The numbers justify maybe a $50 billion number," he said, referring to Facebook's valuation.

Facebook's revenue growth rate - roughly 88 percent in 2011 - would justify a $65 billion valuation, Yoshikami noted, which is far short of the $75 billion to $100 billion that sources have said the company is looking for.

Facebook fatigue?

Facebook's explosive growth has come as first-time users joined the social networking site in droves, which in turn enticed even more to join up. The world's biggest social network now has 845 million members in more than 70 languages.

But with signs that membership growth is slowing, analysts say Facebook needs to get existing users to spend more time on the site and advertisers to spend more money. In the last three months of 2011, Facebook's total monthly active users rose 5.6 percent versus 10.5 percent in the last three months of 2010.

"The hypergrowth is probably over'" said Michael Pachter, head of research in the private shares group at Wedbush Securities. "The low-hanging fruit of the Western developed world has already been penetrated to a large extent...It's just kind of obvious that they're not going to ever get every single person that lives on the planet."

Facebook knows it needs to diversify revenue streams. It has a successful gaming business that nets it 30 percent of the revenue from sales of virtual goods in games like Zynga Inc's Farmville.

But Facebook wants to encourage users to stay for media content, putting it in competition against Apple Inc and Google Inc.

Known for its engineering-driven culture, where innovation and experimentation are prized, Facebook has rolled out a steady stream of new features and capabilities, from video chat to mobile apps. They appear to be ensuring that users keep coming back.

In December, 57 percent of Facebook's 845 million active users interacted with the service on any given day, up from 54 percent at the same time last year, the IPO prospectus shows.

And U.S. users seem willing to devote increasing amounts of time to the site - seven hours each month compared to just over five hours only a year ago, data from industry research firm comScore says.

Boosting that level of engagement, however, will be one of Facebook's challenges. With new competitors hitting the market, from image-sharing site Pinterest to Google+, some analysts warn that social networking "fatigue" might set in.

"There's probably going to be a breaking point in how many of these new technologies consumers can cobble into their lives," said Rebecca Lieb, an advertising and media analyst at research and consulting firm Altimeter Group.

"You still have to eat, you still have to sleep. So the market might become very saturated and shake out," she said, noting that Facebook has a very solid foundation compared to some of the other social networking services.

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