Thursday, 17 May 2012

Facebook and the IPO

Ruairidh Finlayson
The Facebook IPO, regardless of the end result, will differ from the tech IPOs of the late 90s/early 00s. For a start, Facebook is very profitable indeed, therefore not relying on promises of distant and often illusive earnings. Its operating margin is strong at around 50%, higher than many of its listed internet peers have ever been able to achieve.

This suggests that it is a more mature tech company than many of its peers were upon listing. This maturity may come with slower growth rates, which perhaps led to the lower than expected original valuation target being set; $28-35 a share which equated to a valuation range of $76.7bn to $95.9bn against a rumoured $100bn. The valuation, at 23 times last year’s sales, was still punchy. The targeted range has since been narrowed and raised due to high interest, and current investors are increasing the number of shares available to the market. The new $34-38 a share level could even be extended further, raising the company valuation well above the $100bn level.

Whether Facebook will ever be able to achieve the same user numbers and advertising revenue as the ubiquitous Google remains to be seen. The key issues for Facebook are the ability to monetise its user’s time in a non-invasive way. Facebook insists it can do this effectively; however, we have our doubts given the concerns raised by users. By plying users with advertising aimed at them based on their likes/interests/demographics, there is inevitably an invasive aspect, perhaps leading to a retraction of the valuable personal information posted on the site.

High growth rates are something that it does share in common with its forebears; however, there are worries given its exposure to the advertising spend cycle. User growth rates in developed markets are flattening out, for example, in the UK there are 31m users (Source: Socialbakers) so clearly almost everyone that wants an account, has an account. Therefore growth will need to come from further emerging market penetration if it is to maintain its premium rating. Not an easy task in places like China where it has ‘approved’ competition (e.g. Renren).

Lack of control is another commonality, particularly with the newer internet listings. Despite selling down a further portion of his stake, Mark Zuckerberg will retain overall control through voting rights, much like Google’s founders. This should ensure that the listed shares trade at a discount to those with these rights attached.

Potential investors should be wary of this single stock dot-com bubble given the large unknowns, the lack of control and the sky high valuation.

Ruairidh Finlayson
Equity Analyst

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