IPO synopsis: Facebook, a review by The Economist

Here’s a summary of the recent article published by The Economist

Company history

Mark Zuckerberg is Facebook’s founder and CEO.  He envisions a global “social” map that connects people to their friends and interests.  Zuckerberg is 27 years old and owns the controlling interest, which is 28% of the company.  He plans an IPO for the Spring of 2012 that will raise $8 billion, which is the largest flotation ever of an internet company.

The COO is Sheryl Sandberg, a previous manager at Google.  She’s enjoys nearly the same celebrity status as Zuckerberg.

Product

Facebook’s software provides a “social utility” platform/website that lets people exchange information with each other.  Outsiders can develop Apps that work on Facebook’s website.  For example, Timeline is an App that encourages users to build an online chronicle of their entire lives.

Operations

Facebook has a network of 845 million users.  Every day, 250 million photos are uploaded to Facebook’s website (and data center).  Facebook’s network consumes 1 out of every 7 minutes spent by users online.

Strategies

Earn profits from personal data.  Facebook plans to map all the connections between people and their interests in order to design user-specific advertising campaigns.  This information could be provided to other websites in turn for a share of the proceeds earned from advertising.

Facebook credits.  Facebook is developing a virtual currency for use in an online-payments service.  Users could potentially spend the currency to play games or purchase items through social commerce.   An expanded service could be rented by online businesses that competes with other online-payments companies such as PayPal.

Market share

Strong network effect.  People spend more time on Facebook than on rival websites such as Google.  The number of Facebook users is increasing in emerging markets (e.g., India, Brazil) where people seek to contact users who live abroad.  Facebook recently displaced Google’s Orkut as Brazil’s leading social network.

Leading online-display advertiser in the U.S.  Advertising provides 85% of Facebook’s revenue.

Competitors

China blocks the use of Facebook and only allows the operation of Chinese social networks such as Renren and Ozone, owned by Tencent.  Facebook will be more attractive to advertisers if it can penetrate the China market.

Financial information

The 2011 income was $3.7 billion in total sales and $1 billion in net profit.    Sources of revenue:

  • 85% from advertising
  • 12% from subsidiary operations by Zynga, a social games network.

Valuation

Facebook’s estimated valuation is $75-$100 billion.  The private trading of shares in secondary markets implies a value exceeding $80 billion, which is more than 20 times the 2011 total sales (PSR) and 80 times the 2011 net income (P/E).  Justifications of Facebook’s overvaluation:

  1. Rapid growth of the social network
  2. Rapid increase of smart phone users (425 million phones are enrolled on the Facebook network)

Risks

Failed business model.  Social advertising is potentially a massive market, but it’s harder to build an advertising business in a social network than in a search engine like Google’s.  Search engine ads are effective because they are presented when the user is looking for something specific, not because the user wants to socialize.

Loss of critical employees/managers.  COO Sandberg’s defection would be a big loss to Facebook.

New business.  Facebook is a startup that is offering an IPO.

Loss of business.  Users may defect, as they did from MySpace in 2005.

Privacy watchdogs.  In 2011, the FTC forced a settlement in which Facebook agreed to an audit of privacy policies.

Privacy regulations.  There’s a global wave of legislation that attempts to shield the privacy of users.

Antitrust regulations.  Facebook will attract scrutiny of monopolistic policies as its operations grow.

Invester rewards.  Facebook may put its interest in social networking ahead of its interest in shareholder returns.

Updates

IPO update 2/28/2012: Facebook

Reference

Briefing Floating Facebook.  The Economist, 2/4/2012.  http://www.economist.com/node/21546020

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