Facebook's IPO Filing: 5 Things to Watch

Published January 31, 2012

| I.B. Times

Within days, Facebook is expected to file for an initial public offering with the U.S. Securities and Exchange Commission, for the first time doing a public financial strip tease.

That's what a company has to do to obtain public investment as well as satisfy regulators who may raise questions. Last year, highly anticipated IPOs by the likes of Groupon and Facebook partner Zynga were delayed for months in Washington as their boards had to deal with precisely these issues.

Facebook, based now in Palo Alto, Calif. but moving to Menlo Park, Calif., has never revealed anything about its financial operations except to announce membership numbers - 800 million, or nearly triple the U.S. population or 11 percent of global population.

Here are five things to monitor when the IPO is filed:

Who owns the company? Since Mark Zuckerberg, now 27, established it in 2004, shares have been sold to insiders, such as Tyler and Cameron Winklevoss and Eduardo Saverin, whose characters were depicted in "The Social Network," but there are others including Hong Kong tycoon Li Ka-shing, PayPal founder Peter Thiel, LinkedIn CEO Reid Hoffman and Zynga CEO Mark Pincus.

Then there are venture capital investors, including Accel Partners, Greylock Ventures and European Founders Fund; investment banks such as Goldman Sachs, and corporations including Microsoft and Russia's Digital Sky Technologies.

The prospectus will lay out who owns what and how much, as well as if anything is to be sold in the deal. Zuckerberg, for one, apparently sold $100 million worth of shares in 2010 to donate cash to the Newark, N.J. school system. Others may have used secondary exchanges as well.

Key: who cashes out and how much insiders, such as Zuckerberg and COO Sheryl Sandberg, retain.

What kind of revenue does Facebook generate? By comparison, Google reported 2011 revenue of $37.9 billion, up 29 percent, while Yahoo reported revenue fell 21 percent to $4.98 billion.

How "sticky" is Facebook and what kind of revenue is generated from advertisers? eMarketer, a research company, estimates Facebook's 2011 revenue was $4.27 billion, with 88 percent derived from advertising.

Comscore, another researcher, reported Facebook's share of the 2011 market for display ads rose to 27.9 percent from 21 percent in 2010. Yahoo had about 11 percent, with both Google and Microsoft holding  below  5 percent shares.

Facebook may detail how many daily clicks are generated from its users, especially the heavy ones, as well as specify some of its traffic. Still, whatever value is pegged for its shares, it will have to reflect some of these numbers.

Google shares, trading Tuesday at $576.87, value the Mountain View, Calif.-based company at $187.6 billion. Their price-earnings ratio is 19.37.

Yahoo shares, trading at $15.45, value the Sunnyvale, Calif.-based company at $19.2 billion and a price-earnings ratio of 18.85. Of course, given Yahoo's recent history, investors including Daniel Loeb's Third Point Capital believe Yahoo's current price masks billions of untapped assets in foreign investments.

By contrast, shareholder Microsoft's market value is $246.5 billion and its price-earnings ratio is 10.64. Goldman Sachs's value is $55.3 billion and price-earnings ratio is 25.4.

How profitable is Facebook? The question is what kind of business is Facebook? While the company must spend heavily on technology and software to keep its sites up constantly, with engineers as well as server farms, its costs should not be that high.

Still, is Facebook a software company? A networker? An advertiser? How about its role in games and e-commerce?

Google, for example, is hugely profitable. Its gross margins, or revenue less total costs and expenses, is 69 percent. Yahoo's is the same. Microsoft's, for the year ended June 30, was 61 percent.

Zynga, for the nine months ended Sept. 30, reported gross margins of 65 percent. So we can estimate Facebook's profitability is in that ballpark.

Where will future growth come from and what's the competition? Nobody will want to invest in Facebook without hope of making money. Obviously, investors want to know how Zuckerberg will double and triple membership? At what cost? And how will that affect ads and e-commerce?

How do you grow a company that already reaches 800 million?

How about challengers? Google reported signing up 90 million members to rival Google+ in just the second half of 2011. At that pace, the number now may exceed 115 million. LinkedIn, the professional social networking site, reported 131 million members in the third quarter, a 63 percent gain over 2010.

Perhaps unappreciated is that Facebook knows a whole lot about its 800 million members and that data is valuable to advertisers and others. Zuckerberg could use it to launch media ventures, network and other businesses, maybe even create a global bank of e-commerce.

Who'll manage the deal? Goldman Sachs, which is already an investor and brought in clients such as Digital Sky in 2010, clearly wants to be the leader. Reports say Morgan Stanley, which handled Zynga's December IPO with Goldman, will be the manager.

While the management doesn't mean much for individuals, whoever handles the IPO matters a lot for Facebook management because it will have to deal with regulators, handle queries from big investors and ultimately run a roadshow.

As well, let's assume Zuckerberg asks his members to participate, giving them shares at a discount or even free; either way, registering and monitoring them could be a technical headache that could be unprecedented.

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