Facebook could be the next Google

The most anticipated IPO since Google is in motion. Facebook is going public and its 27-year-old founder – Mark Zuckerberg – will enter the rarified air of the world’s wealthiest people.
The $10 billion question is whether Facebook will follow in Google’s footsteps or mimic the more recent and less impressive Internet IPOs like Linkedin and Zynga.
I’m reticent to weigh in because I thought investing in Google’s IPO was folly. It would be easy to jump on the bandwagon, but my gut tells me Facebook’s long-term financial prospects will fall short of Google’s. Then again, my gut is more AARP material then a prime Facebook demographic. I must temper the fact that I have no use for the product against the reality that 845 million other people do.
Yes, Facebook has 845 million users, an advertising jackpot. But its user base is also part of the company’s challenge. Where’s the upside? The company’s own filing cited only 2 billion global Internet users – meaning Facebook already has more than a 40 percent market share.
Is the global population large enough for Facebook to match Google’s growth? The world population is about 7 billion people of which approximately 1.5 billion are either younger than 9 or older than 50. That leaves a total “market” of 5.5 billion. And something tells me many of those people aren’t carrying around iPhones. Also consider that China’s population alone is 1.2 billion where in the near term Facebook can’t play due to government censorship of the Internet.
The primary growth markets are basically India, the rest of Asia and Eastern Europe. But Facebook’s penetration rate in India is only a third to half that of the U.S. and penetration in Japan, Russia and South Korea is even lower. In part, this is the result of strong local competitors, but it’s also possible that cultural barriers exist that inhibit Facebook’s ability to duplicate U.S. adoption rates.
Nonetheless, the company’s financials are impressive. Last year Facebook generated a $1 billion in profit on $3.71 billion in revenues. Over the past two years, revenues have increased at a rate of 118 percent and operating margins average 49 percent.
Advertising accounts for 85 percent of revenues with the remainder coming from social gaming and other fees. From 2010 to 2011, the number of ads delivered grew 42 percent and the price per ad increased by 18 percent.
These are Google-esque numbers as are Facebook’s profit margins. And Facebook’s growth is slightly higher than what Google registered in the years surrounding its public offering.
As impressive is the estimate that Facebook will IPO at between 75 and 100 times earnings. Such a lofty P/E harkens back to the dot com days.
A major risk in investing in Facebook is that doing so is placing a heavy bet on Mark Zuckerberg’s ability to sustain the company’s momentum.
That’s because the company plans to issue two classes of stock, and Zuckerberg will retain 57 percent of the voting stock. And the company’s structure means it won’t be required to have independent outside directors.
So the question is: how much faith do you have in a 20-something CEO who is more passionate about “the cause” than the cash?
Zuckerberg is an idealist, albeit a brilliant one. But he is only 27 and may not fully grasp or accept the realities of the world.
Some of Mr. Zuckerberg’s perspectives on life and business provide insight into his management philosophy:
“Facebook was not originally created to be a company. It was built to accomplish a social mission.
“We don’t build services to make money; we make money to build better services.”
Call me a cynic, but I’m fairly certain that isn’t the mindset of the majority of investors.
He also believes:
“These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits.”
You’d like to think so, but I suspect most people couldn’t care less about whether a company believes in something. What the majority of consumers care about is buying a good product at a good value. Perhaps this generation will be different but I wouldn’t bank on it.
Other musings include:
“Society is at a tipping point because of the Internet. Facebook gives people the power to share and help them once again transform many of our core institutions and industries … That includes changing government … Over time, we expect governments will become more responsive to issues and concerns raised directly by all their people rather than through intermediaries controlled by a select few.”
These are noble thoughts that I hope come to fruition, and I admire Zuckerberg for attempting to leverage Facebook to forward these goals. But will doing so make a good financial investment? For Facebook to replicate Google’s success, it must not only grow its user base but also squeeze more from existing users.
To accomplish that, it must establish new forms of advertising including the soon-to-launch “Sponsored Stories” which provides advertisers access to the crown jewel home page.
So here’s my take: Facebook’s stock will take off like a rocket shortly after the IPO, then come back to earth. It will tread water for a quarter or so then gradually ascend.
However, in the long-term I don’t see Facebook matching Google’s stock appreciation track record.