Since its Securities and Exchange Commission (SEC) filing in early February, news of Facebook's initial public offering (IPO) has been associated with words such as "overvalued" and "overhyped," and more or less insinuated as a harbinger of a second dotcom bubble. Its preliminary $100 billion valuation trumps Google's colossal initial IPO market cap of $23, leaving some observers left wondering what warrants such a huge price tag. However, despite the apprehension of many tech investors, this upcoming spring, Facebook's stock release will undoubtedly be the largest tech IPO in years, raising at least $5 billion.

The prospectus filed to the SEC lists numerous risk factors that echo the public opinion of Facebook's current position in the online world - risks such as the inability to retain existing users, a scenario which was realized in May of 2011 as 7 million American and Canadian users left the site. Yet there were a handful of items listed in the filing of notable interest that could, if executed well, bring some justification to the company's high valuation. However, on the other hand, these factors could also just end up giving Facebook a black eye.

Revenue Per User
With its purported 845 million monthly active users, Facebook lords over other related social networking sites, such as LinkedIn, which has an estimated 49 million monthly views, Twitter with 92 million and Tumblr 47 million, compared to Facebook at about 150 million monthly views. In its prospectus published earlier this month, Facebook has earned revenue of $3.7 billion. As a company that relies heavily on advertising to its massive user base, this equates to about $4.38 of revenue per active user on the site.

Assuming they can double their active users to 1.69 billion (which can be tangibly achieved if China opens its online borders) at $4.38 per user, Facebook could earn $7.4 billion; if they can double the $4.38 in addition, they will be looking at $14.8 billion. To put this in perspective, Google earned unaudited revenue of $37.9 billion in 2011. Thus, the questions remain: is Facebook capable of growing its active users? Or even squeezing out more than $5 a person?

The Facebook Platform
Unlike many of its social media peers, Facebook provides a platform for third party developers to create and integrate apps into the social network's infrastructure. In 2011, Facebook derived approximately 12% of its revenue from casual gaming company Zynga, which develops social apps such as "CityVille," "Zynga Poker" and "Mafia Wars 2." The company is financially supported through ad revenue and income derived from the sales and purchase of virtual goods. In its 2011 fourth quarter earnings report, Zynga collected revenue over $311 million, barring its net loss of $435 million due to expenses.

With each transaction Zynga makes, 30% of it goes towards Facebook as per their five-year commitment. Assuming this relationship is maintained, this can bode well for both groups. However, recent speculation shows that Zynga is moving away from Facebook and hopes to determine itself as an independent game publisher. This may put a dent in the earnings for Facebook, unless they can bring in other developers and third party companies into the foray and continue the monetization of their platform.

Growth and Facebook Mobile
In the interceding year between the end of 2010 and 2011, Facebook saw a 39% growth in monthly active users; notably in Brazil, where Orkut is the social media site of choice, growth reached 268% from the previous year as 37 million users signed on. As mentioned before, China's population is a potential area for Facebook, however in order to penetrate that market several regulatory hurdles need to be overcome, as well as compliance to foreign laws regarding censorship - not to mention competition with their own social media sites such as RenRen and Sina. If in the foreseeable future Facebook in its intact form can enter China, billions of potential users will be accessible and subsequently, available for ad targeting.

Moreover, in 2011, about 425 million users accessed Facebook via a mobile device, which at the moment does not draw any ad revenue. If it chooses to capitalize on this venue, it could potentially draw significant revenue. Conversely, given the relatively small screen real estate on most smartphones, this may deter users from accessing the site in this manner.

The Bottom Line
In spite of criticism regarding its valuation, the fact remains that Facebook has captured a significant percentage of the online tech market and continues to be a major player in the recent stream of web 2.0 stocks. It maintains a user-friendly interface, frequently seeks to innovate and expand its presence on the internet and has become a staple in the lexicon of modern day conversation.

Facebook could potentially fail to mirror the evolution of Google, which emerged as an entity entirely different than initially anticipated, if the three reasons listed above are not deeply invested in by its developers. However, it could very well go beyond popular negative expectations if it ends up being successful in the face of its business risks. Either way, the months following Facebook's IPO release will prove to be interesting.

Related Articles
  1. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  2. Active Trading Fundamentals

    The Companies of Peter Theil's Founders Fund

    Learn about the major public companies that Peter Thiel has invested in and companies that are on the verge of going public at multibillion-dollar valuations.
  3. Investing Basics

    If You Had Invested Right After Amazon's IPO

    Find out how much you would have made if you had invested $1,000 during Amazon's IPO, including how the power of the stock split affects investment growth.
  4. Stock Analysis

    6 Things to Know About Soul Cycle Stock

    Learn about SoulCycle and how it has found success. Understand six aspects of the company everyone should know before considering an investment in SoulCycle.
  5. Stock Analysis

    5 Things to Know About Neiman Marcus Stock

    Learn about Nieman Marcus and how it has become successful. Understand five aspects potential investors should know about the company.
  6. Stock Analysis

    5 Things to Know About Planet Fitness Stock

    Learn about Planet Fitness and how it has achieved success. Understand five aspects of the company that have made it an attractive investment.
  7. Stock Analysis

    Is the Apple Watch a Real Threat to Fitbit?

    Examine the potential for marketplace competition between Fitbit and the Apple Watch in the rapidly growing consumer wearables industry.
  8. Professionals

    10 Must-Follow Broker-Dealers on Social Media

    Stay in the financial markets 'know' by following these influential independent broker-dealers on social media.
  9. Investing

    Dick Costolo Biography

    Dick Costolo is a very polarizing man – half the world credits him with saving Twitter Inc. (TWTR) from its own popularity and making initial investors rich while the other half blames him for ...
  10. Investing Basics

    What is a Public Company?

    A public company has sold stock to the public through an initial public offering (IPO) and that stock is currently traded on a public stock exchange.
RELATED TERMS
  1. Venture Capitalist

    An investor who either provides capital to startup ventures or ...
  2. Dog And Pony Show

    A colloquial term that generally refers to a presentation or ...
  3. Red Herring

    A preliminary prospectus filed by a company with the Securities ...
  4. Muppet Bait

    Naive investors who are lured into buying hot stocks or securities ...
  5. At A Discount

    This specifically refers to stock that is sold for less than ...
  6. Crowdfunding

    The use of small amounts of capital from a large number of individuals ...
RELATED FAQS
  1. What kind of assets can be traded on a secondary market?

    Virtually all types of financial assets and investing instruments are traded on secondary markets, including stocks, bonds, ... Read Full Answer >>
  2. Why would a company decide to utilize H-shares over A-shares in its IPO?

    A company would decide to utilize H shares over A shares in its initial public offering (IPO) if that company believes it ... Read Full Answer >>
  3. How do I place a buy limit order if I want to buy a stock during an initial public ...

    During an initial public offering, or IPO, a trader may place a buy limit order by choosing "Buy" and "Limit" in the order ... Read Full Answer >>
  4. How do corporate actions affect floating stock?

    Corporate actions, defined as a company's actions that affect the amount of outstanding company stock shares, can either ... Read Full Answer >>
  5. What are the advantages and disadvantages of listing on the Nasdaq versus other stock ...

    The primary advantages for a company of listing on the Nasdaq exchange are lower listing fees and lower minimum requirements ... Read Full Answer >>
  6. What securities does the primary market deal with?

    The primary market deals with all newly issued securities. When businesses, governments or other groups want to raise capital ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!