Facebook’s Monetization Potential

Finally, the most-awaited tech IPO is round the corner. Social media giant Facebook  filed their S-1 this week, thus ending the long wait. Facebook plans to raise $10 billion through this IPO. According to Dealogic, an IPO of this scale will make the IPO the biggest ever in tech, surpassing Google’s $1.9 billion IPO debut in 2004.

Facebook’s Growth
Facebook’s community grew 39% over the year to over 845 million members worldwide. These members uploaded 250 million photos, posted 2.7 billion likes and comments and enabled 100 billion “friendships” each day. Revenues increased 88% over the year to $3.71 billion, and in contrast to other contemporary Internet tech players, they reported an impressive operating profit of $1 billion. Margins grew 65% over previous year’s $0.61 billion.

According to eMarketer, Facebook’s revenues are projected to grow by 52% this year to $5.78 billion. Facebook earns 85% of their revenues from advertising and the balance from the transaction of virtual goods, social games, and other fees. Transactions held on Sharespost suggest that Facebook was valued at $81.2 billion when they halted trading of their stock on the secondary markets trading site. Following listing under the ticker FB, the market expects the company to be worth $75 billion-$100 billion.

To help put Facebook’s massive size in perspective, only three other companies have had IPOs of more than $10 billion: AT&T, GM and VISA. Mashable.com has an excellent, extensive infographic to help put the event in context.

Facebook’s Acquisitions
Facebook’s acquisitions continued during the quarter as they added several other smaller teams to their portfolio. They recently acquired Austin-based Gowalla, a location-based social networking player. Gowalla’s mobile app lets users share pictures and other content about their favorite places with friends and family. Following the acquisition, Gowalla’s app will continue to function independently. However, their leadership and development team will become a part of Facebook and help Facebook improve their Timeline offering. The Timeline, launched last year, changed user profile pages to look more like scrapbooks detailing events in their lives through pictures, comments, status, and recent activities.

In November 2011, they acquired WhoGlue, a Baltimore-based two-employee startup. WhoGlue develops software for membership organizations, and Facebook plans to use their skills to help develop private social networks. They also added another two employee organization, MailRank, to their list. Startup MailRank has developed an email prioritization system. MailRank’s technology has not been bought by Facebook, but their two co-founding employees will now work with Facebook, possibly to help improve the company’s messaging services.

To improve user engagement, Facebook also bought Digital Staircase, a photo and video app maker. Digital Staircase has developed several apps that work on the iOS platform and let users edit photos and video streams. The acquisition will help Facebook launch their own standalone photo or video apps.

Despite these moves, I remain skeptical of their $100 billion projected valuation. I agree with Peter Cohan’s view:

“On a price/sales basis, Facebook would trade at 19.7 — that’s 497% higher than Apple (APPL) at 3.3 and 294% above Google’s (GOOG) P/S of 5. And assuming Facebook shares Google’s net margin of 26%, Facebook’s P/E of 80 is far higher than Google’s 19 or Apple’s 12.7. This means that Facebook’s stock might not hold up after the first-day IPO pop — the same fate that greeted most of 2011’s tech IPOs.”

In general, though, there is a tremendous amount of unmonetized value in Facebook. With 850 million users, the rate of monetization needs to go up significantly. Ad rates will likely go up over the years as people in the industry figure out better technology to target and engage, and give higher returns to advertisers. But there are other opportunities as well, one of them being search, a segment Google still dominates. Facebook could foray into search and leverage their data to offer an orders-of-magnitude better user experience. It could also release apps of its own or acquire some good apps that have high monetization potential.

There are many options to amplify the monetization level of this massive population of highly engaged users. If investors get a sense that Facebook is focusing on those opportunities, the stock will hold up.