Facebook's IPO: The growth wild card

The social network may actually be young in years, but it'll resemble a more mature Web business in short order if it can't keep its growth rates going.

Facebook's road show for its initial public offering is apparently set to begin, but questions abound about the company, its valuation, and the return on ads. The biggest question, however, may revolve around future growth.

The Wall Street Journal has highlighted Facebook's roadshow as well as the doubts about the IPO. Facebook will certainly garner investor interest, but it's unclear whether there's $100 billion worth.

Here's the conundrum for Facebook investors in a nutshell:

Facebook monetization rates. Facebook's IPO Filing

  • Facebook already has 901 million active monthly users. Where are the growth markets sans China and India? What happens when everyone has a Facebook account in emerging markets? Short answer: Get ready to watch Facebook churn rates.
  • To generate revenue growth to justify a $100 billion valuation, Facebook will have to ramp ads.
  • If Facebook ads ramp, it could possibly annoy its users.
  • Those users may not deliver the returns on advertising investment to justify investing in Facebook.
  • Simply put, it's quite possible that Facebook may not be a monetization machine like Google.

In other words, Facebook may actually be young in years, but resemble a more mature Web business in short order. Facebook's first quarter results highlight how this growth issue could become a major pain in Mark Zuckerberg's backside.

For the three months ended March 31, Facebook reported net income of $205 million on revenue of $1.06 billion, up from $731 million a year ago. Facebook, however, said the first quarter was seasonally slow.

We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect strong growth in advertising revenue between the third and fourth quarters and slower growth, and for certain years a decline, in advertising spending between the fourth and subsequent first quarters...The rapid growth in our business may have partially masked these seasonal trends to date and the seasonal impacts may be more pronounced in the future.

Those seasonality comments cast Facebook in a new light. In fact, Facebook shares have already been downgraded -- even though they haven't traded yet. Pivotal Research Group analyst Brian Wieser issued a research note declaring that Facebook's first quarter was disappointing. Wieser said:

First quarter results suggest operating margin challenges, reducing enterprise valuation from $82 billion to $75 billion...We now must incorporate into our model new concerns around operating expense management, especially given the diminishing growth in the overall business during the quarter.

Another potential concern relates to the pace of deceleration in the United States. We estimate growth of advertising revenue was likely in the low double digits in the U.S. during the first quarter. By contrast, international advertising was likely very robust, growing by more than 60% per our estimates during the same period.

Wieser's big beef is that Facebook doesn't have the profit margins to invest heavily in its business. Companies like Google and Amazon are often forgiven for investing in infrastructure because they still beat bottom line projections. If Facebook can't monetize well, analysts will start panning the social network. It doesn't help Facebook's perceptions that it paid up for Instagram as well as patents from Microsoft.

The bottom line: Facebook's growth and monetization are going to be ongoing concerns. Should be a fun bunch of quarterly conference calls following the IPO.

 

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