Why Facebook Needs More Cash

By Angie Mohr | April 04, 2012 AAA

As Facebook approaches the release of its initial public offering (IPO), which will raise $10 billion for the 8-year-old Internet giant, many customers and investors are speculating as to what it will do with all that money and whether it's enough. A $10 billion capital raise catapults Facebook's IPO to the fourth largest, after VISA, General Motors and AT&T Wireless. Moreover, the IPO will make the company number one in Internet company offerings.

SEE: Evaluating the Facebook IPO

Financial Needs
The problem with analyzing Facebook's capital needs is that the company is currently private and, therefore, releases very little financial information publicly. Analysts and research firms estimate Facebook's annual revenues at approximately $3.8 million. How it disperses its cash inflow is unknown. We do know that in 2009 the company was seeking new debt financing after having a line increase denied by a current creditor. Facebook needed more funding to lease additional computer equipment to host and service its ever-growing base of users, which has more than doubled over the past few years.

Workforce
As Facebook grows its user base, it will also have to grow its labor force. In 2011, Facebook set up a second headquarters, having outgrown its first. Further growth will increase the company's need for physical office and development space, as well as new employees. According to CNET, Facebook intends to grow to a staff of 9,600 in the next few years. That type of instant growth requires a lot of capital, especially when there are still questions about Facebook's overall profitability.

Revenue
Currently, Facebook's main source of revenue is derived from advertising on the site. Companies pay per display for ads that appear on the right hand side of a user's account. Advertisers can specify which users can see their ads, defining the target market that best suits their budget. While it is likely that ads will continue to be a main source of income for Facebook, the company is expected to branch out into other areas currently occupied by its competitors, such as Google and YouTube. Google's continued advance into Facebook's territory has forced Facebook to ramp up its team to give users a richer experience and and to attract more advertisers. This continued development will take a chunk of the IPO funds.

The big question is: will Facebook buy more companies with its newfound wealth? If it wanted to take a run at Google's search engine, it could make an offer for Yahoo or Bing. Yahoo's valuation is unclear, especially in light of its recent poor performance. Microsoft is unlikely to give up Bing as it is holding its own as a legitimate search engine contender. If Facebook contemplates any purchases, they will likely be smaller companies with potentially valuable patents and licenses. However, Facebook's history suggests that it is more willing to collaborate with other companies (such as Spotify and Netflix) than to buy them outright.

Perhaps one of the best plans for Facebook's new wealth will be to keep it in the bank. Although it has had an impressive track record of growth, its ability to turn a profit is still a question mark and it is likely that the company will need rainy day funds in the future. This is especially true as Google continues to develop its "Facebook Killer" product, Google Plus.

The Bottom Line
Being able to garner $10 billion in an IPO is an impressive feat, but all that is important is how Facebook employs that capital. As investors wait for the initial filing, Facebook is keeping its plans close to its chest.

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