Will the market friend Facebook?

Business Spectator

Last year there was a raging debate in the US about whether the soaring valuations for internet companies represented a boom, or a bubble. With Facebook apparently set to launch an initial public offering this week, valuing it at between $US75 billion and $US100 billion, the market's willingness to capitalise the optimism around social networking businesses is about to be tested.

There have been a string of reports over recent days that Facebook is about to file the initial paperwork for an IPO with the Securities and Exchange Commission which would seek to raise $US10 billion and value it at up to $US100 billion.

Anything close to the upper end of that range – Facebook shares have been trading privately at levels that value the company at about $US80 billion – would make it the biggest-ever float of an internet company and one of the bigger floats in history.

It would also represent one of the bolder signals of investor confidence/optimism in history, even without factoring in the volatile and fearful market environment.

Facebook is a relatively young company. It was founded only in 2004. While it has about 800 million worldwide users and is expected to breeze through the one-billion-users mark sometime later this year, it isn't a finally mature business and in many respects is still searching for ways to monetise its vast and very engaged audience.

While its financials are private, there is apparently informed speculation that Facebook earned about $US1.5 billion last year on revenues of almost $US4 billion and some projections that its revenue base will grow to around $US7 billion this year. 

To put those numbers in perspective, Google earned $US9.7 billion on $US38 billion of revenue last year but, at $US187 billion, has a market capitalisation less than twice that of the more optimistic assessment of Facebook's likely market value.

Apple announced quarterly revenues of $US46 billion and earnings of $US13 billion last week – but has a market capitalisation just above four times that postulated for Facebook and $US100 billion of cash in the bank.

Is it possible that Facebook could be valued by the market at $US100 billion? Anything is possible but that could only occur if investors were convinced that the company's user base could continue to grow indefinitely and dramatically, while it devises better ways to monetise that audience than simply putting corporate brands in front of it.

With the level of information Facebook collects on its users, their social networks and their likes and dislikes it is conceivable that having built the audience it will be able to cash in on advertisers' desire to better target their dollars and maintain or even increase what are already very impressive margins.

In effect, however, a $US100 billion capitalisation implies two leaps of faith: one is the continuing ability to grow the Facebook user base strongly and indefinitely and the other is a yet-to-be-demonstrated mechanism for generating new revenue streams from that audience.

The listing doesn't appear to be a quick grab for cash by founder Mark Zuckerberg, whose preference for keeping Facebook and its financial performance private has been undermined by the growth in its shareholder base to the point where he would be forced to disclose the company's financial information anyway.

It is also worth noting, that unlike the dot-com bubble floats in the late 1990s, Facebook actually does have, not just eyeballs or revenues, but real earnings, and relatively high-margin earnings at that. It has some substance to it and it does dominate its segment of the internet.

Mind you, there was a time, before Facebook demolished it, that MySpace once dominated that same segment and when Microsoft (which has a $US245 billion market capitalisation) was seen as invulnerable, before Google arrived on the scene.

Do its prospects warrant among the most optimistic multiples that Wall Street can place on a stock? 

You could argue the case for that but, equally, there are those sceptical that it can continuously and indefinitely increase both its user numbers and the intensity of their engagement. What if the Google network launched by Google last year in response to Facebook's growth takes off or some other hot new site and concept captures the imagination of fickle and fashion-conscious networkers?

It is the fact that these sorts of questions are unanswerable – and that the numbers involved are seriously large – that makes the prospect of a Facebook IPO a real and fascinating test of the market's conviction and confidence in the potential to fully commercialise social networks.