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. Stock Analysis

    Is the Stock Market Crashing? 5 Signs to Consider

    Learn about some signs of a potential stock market crash including a high level of margin debt, lots of IPOs, M&A activity and technical factors.
  2. Professionals

    How Advisors Can Carve Out a Social Media Niche

    Social media is a great way for financial advisors to build a brand and potentially generate leads if it’s properly used. Here are some tips.
  3. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  4. Stock Analysis

    Social Media Networks That Are Cashing in on the 2016 Presidential Election

    Learn how social media continues to shape the way political campaigns are run. Through social networks, candidates can reach voters directly like never before.
  5. Investing News

    Thursday Intel: Will Q4 Offer a Fresh Start?

    Investor hopes for a fresh start to the world economy in this quarter may be misplaced.
  6. Entrepreneurship

    5 Ways to Make Money on Twitter

    Find out how people are making money online on Twitter, and get some ideas that can turn Twitter into a source of revenue for you or for your small business.
  7. Fundamental Analysis

    Top Reasons IPO Valuations Miss The Mark

    The costly services of investment banks don’t necessarily guarantee accuracy in IPO pricing.
  8. Investing Basics

    Taking the guesswork out of IPO analysis

    Burned by IPOs before? Fear not. Learn how to distinguish overhyped new public companies from ones with a little more promise.
  9. Investing Basics

    5 Tips For Investing In IPOs

    It’s not easy to profit from IPO​s, but the money is there.
  10. Investing Basics

    5 Tips For Investing In IPOs

    Thinking of investing in IPOs? Here are five things to remember before jumping into these murky waters.
  1. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>

You May Also Like

Hot Definitions
  1. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  2. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  3. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  4. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  5. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  6. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
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!