May 15, 2012

Facebook IPO Hype Reaches Crescendo As Analysts Assess Dot-Com's Opportunities, Risks FB - Investors.com

Facebook founder and Chief Executive Mark Zuckerberg at a conference in San Francisco.

THE BUZZ

In case you've been living in a deep-sea cave and missed it, Facebook has to be the most anticipated IPO at least since Google (GOOG) debuted in 2004. Everything about it seems outsized. Its expected $10.6 billion raise would be the fifth largest in U.S. history. Its list of 33 underwriters seems to include everyone who ever had coffee on Wall Street. And when it put its investor presentation up on retailroadshow.com, the site had to host it on a separate page so it wouldn't crash the server.

The gigantism suits Facebook itself, whose customer base includes a significant chunk of planet Earth. At the end of the first quarter, its online social network had more than 900 million monthly active users, and some uncounted number of less frequent communicants who add up to 125 billion "friend" connections. As a result, Facebook comes to market with financials more like the debutante Google than your typical overhyped dot-com, with $3.7 billion in revenue last year and several years of solid profitability.

Sterne Agee analyst Arvind Bhatia took the unusual step of initiating coverage with a buy before the stock even priced, and made the Google analogy explicit.

"Just like Google did less than a decade ago, we believe Facebook is disrupting the worldwide advertising market," he wrote in his May 7 report. "We think FB can more than triple its revenue and EBITDA over the next four to five years."

Others were a bit more tempered, noting the youth of both the company and its founder. In a report issued May 11, Morningstar analysts called the firm "prepubescent" and concluded: "The enthusiasm for Facebook is not misplaced, but the market may be underestimating several near-term challenges for the company."

THE COMPANY

As has been much chronicled, Mark Zuckerberg founded Facebook in 2004 when he was a Harvard student. At first, it used static profiles more like LinkedIn (LNKD), but over time it has gone in a more narrative direction. By now, users can share where they are, what they're reading, what music they're listening to, whom they're with, and practically anything else in a time-stamped sequence.

Since creating and using a profile is free, Facebook derives its revenue from two other sources. Advertising provides more than 85%, which the company can sell based on its enormous but finely sliceable audience. Ads can display only for users of certain ages, gender, "likes" and so on. Advertisers can pay by impressions, by clicks, or by bidding. Facebook also offers an analytics platform for advertisers to track use.

The rest of the company's revenue comes from its cut of payments made to developers of third-party apps, mostly games. Games such as Zynga's (ZNGA) FarmVille are free to play, but players buy virtual goods as they go along. Facebook takes 30% of each payment.

Facebook's site was developed for desktop computers, but its more recent mobile app has some 488 million monthly active users. It did not actually start including ads in it until two months ago. But its purchase of photo-sharing site Instagram last month was one of its preparations for a mostly mobile future.

Geographically, Facebook's user base is extremely global, with some 80% of users outside the U.S. The big hole in its map, however, is China, which blocks the site. Analysts say the possible opening of China is a "wild card" that could change the company's future.

RISKS/CHALLENGES

Facebook's extremely short history with mobile advertising has raised some concerns. The prospectus notes that "increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered." Thus, revenue per user is lower.

Return on investment in Facebook advertising is also a concern. "The most common theme we heard in talking to advertisers and agencies was the lack of standards and clear ROI in running social advertising campaigns," wrote Morningstar's analysts. "If agencies and advertisers are not able to develop acceptable tools for measurement, growth in social advertising may stall and the value of Facebook will be as generic as any other website that drives traffic."

Morningstar also notes that the Instagram deal reportedly occurred with little involvement from the Board of Directors, as Zuckerberg retains voting control of the company. This raised questions about what kind of controls there might be on overspending.

The company's extensive use of stock-based compensation has made the quarters look lumpier than they are on an operating basis. Analyst Bhatia calculated that first-quarter EBITDA rose 33% over a year ago, but stock compensation led to a net decline.

Many users have complained about privacy and Facebook's use of their data, making it likely that governments will regulate it as it turns into more of an institution. Since sharing user data is one of Facebook's key selling points to advertisers, that could damage its revenue.

THE RESULTS

Revenue in the first quarter rose 45% over the year-earlier quarter to $327 million. Net income reversed its past growth trend and declined 12% to $205 million, due mostly to an increase in share-based compensation expense.

USE OF PROCEEDS

Facebook expects to raise $5.6 billion from its offering of 337 million shares, or $5.8 billion if the underwriters exercise their options in full. It will use the money for working capital and general corporate purposes.

THE MANAGEMENT

Mark Zuckerberg

Chief executive and chairman

Founded the company; became CEO in 2004 and chairman in January. Studied computer science at Harvard University.

Sheryl Sandberg

Chief operating officer

Joined in 2008 after seven years in various positions at Google. Formerly chief of staff at the U.S. Treasury Dept., consultant with Mc-Kinsey, and economist at the World Bank. She holds an MBA from Harvard University.

David Ebersman

Chief financial officer

Joined in 2009 after working as CFO and executive vice president of Genentech, now part of Roche (RHHBY). Previously worked as a research analyst at Oppenheimer. He holds a BA in economics from Brown University.

Facebook Inc.

Menlo Park, Calif.

(650) 308-7300

facebook.com

Lead underwriters: Morgan Stanley, JPMorgan and Goldman Sachs

Offering price: $28-$35

Expected date: May 17

Ticker: FB

by Amy Reeves Investor's Business Daily May 14, 2012


Facebook IPO Hype Reaches Crescendo As Analysts Assess Dot-Com's Opportunities, Risks FB - Investors.com

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