The planned initial public offering in May of social media site Facebook is expected to raise $5 billion or more, at price-earnings multiples not seen since the days of the dot-com boom. Some observers wonder if the Facebook IPO represents the beginning of another stock market bubble that could burst, leaving investors holding worthless securities. But while there are some similarities, the Facebook IPO could be different, say some faculty at Emory University’s Goizueta Business School.
“With 845 million monthly users and 483 million daily users [as of the beginning of the year], Facebook has a right to sell its ‘growth potential’ to investors,” says Benn Konsynski, a chaired professor of Information Systems and Operations Management at Goizueta. “However, if the IPO launches with a price to revenue ratio of 25 to 30, it would be rather far off the charts. After all, Google was priced at about nine times revenue at the time of its IPO.”
But the prospect of an overheated IPO isn’t likely to damage Facebook’s long-term prospects, Konsynski adds.
“The initial multiplier might be the cause of some concern, but the fact is that revenue is rising, with the company bringing in $3.7 billion in 2011, compared to $1.9 billion in 2010,” he notes. “Is this another Google story? Sure for a while it will be treated as such. The initial market will likely be less than rational and FB will have to earn its way into the fair valuation, but then again Google did it — and then some. The fact that more than 12 percent of Facebook’s revenue is related to its partnership with Zynga [a social game developer that has more than 227 million monthly active users] might worry some investors, but no single partnership will tell the future story for Facebook. Instead, Facebook is a platform and will likely see a parade of partners.”
One reason that Facebook’s valuation isn’t likely to spark another market bubble is that the technology segment is more mature now compared to the 1999-2000 period, suggests Narasimhan Jegadeesh, a chaired finance professor at Goizueta.
“The increase in new tech and social networking firms is helping to create new market spaces, but the investor reaction is more measured now,” he says. “Back in the late 20th century, no one knew what the growth rate for these Internet firms would be like, so there was rampant speculation. Today, people have better understanding so investors tend to be more rational.”
Becoming a publicly traded company will undoubtedly present Facebook with more access to capital, but it will also face some challenges, according to Jegadeesh.
“I’m not too worried about Sarbanes-Oxley and other compliance costs,” he said, referring to the federal Sarbanes–Oxley Act of 2002, which set new or enhanced standards for publicly held companies. “Sarbanes-Oxley is relatively expensive but the dollar amount is mainly material for smaller companies. But the fact is that a lot of information has to be disclosed by public companies and that can be a competitive disadvantage for some firms. But I don’t think it outweighs the advantages for a company like Facebook.”
Facebook’s challenge instead may come from competitors like Google that may target its social networking space.
“Facebook and its CEO Mark Zuckerberg were able to marginalize MySpace [an early social networking site that was the leader in the field at one time], but the biggest threat today to Facebook is probably Google+, since Google has deep pockets and many alliances in place,” says Jegadeesh. “On the other hand, Facebook already has a significant network, which is effectively a barrier to entry for Google+.”
One potential Facebook weakness is its reliance on the social networking segment for the majority of its revenue.
“Facebook’s platform drives its advertising revenue,” he explains. “But Google’s revenue stream includes search engines and potentially its venture into mobile platforms with Android and Chrome, so it has a more diversified set of revenue streams.”
Whether Facebook will be able to successfully expand its revenue sources is an open question. Its attempt to branch out into a merchant discounts and rewards program based on the Groupon model was not successful. After a four-month testing period, Facebook dropped the idea.
But Facebook also has some competitive advantages.
“Facebook has lot of deep demographic and other information about its users,” Jegadeesh says. “Also, the average time a user spends on Facebook exceeds the average time a user spend on Google. All of this can make Facebook’s platform more attractive to advertisers.”
To remain competitive, Facebook has to continue to enhance the user experience, he adds.
“Users will stay on the site longer if they have a satisfactory experience,” says Jegadeesh. “That will help Facebook to sell advertising. The company is branching out into other revenue generators, like selling virtual items for online games, but Web advertising will likely remain its main source of revenue for some time.”
Jegadeesh is optimistic about Facebook’s future, but he says it can’t rest on its laurels.
“People are spending more time on the Internet, so if Facebook can continue to bring virtual interaction closer to personal interaction, it has a good chance of continuing to be successful,” he observes. “But the key will be its ability to continue to innovate. So far, Zuckerberg has been a prime mover behind that, but as the company matures it can’t depend solely on its founder. Microsoft’s Bill Gates moved away from his central role as the company matured, which positioned it for long-term growth. At some point, Zuckerberg will have to position Facebook to do the same thing.”