Facebook's IPO: What Wall Street still wants to know

As expected, Facebook showed off some impressive financial and usage figures. But some on Wall Street are left wondering how the company plans to make money off its extraordinary large user base.

A Lego model of the Facebook logo sits on the desk of a programmer inside the company's office in Palo Alto, Calif., in June 2009.
A Lego model of the Facebook logo sits on the desk of a programmer inside the company's office in Palo Alto, Calif., in June 2009. James Martin/CNET

Facebook has tremendous potential to become a cash-generating machine, but can it capitalize on its opportunities?

That's the question a lot on Wall Street are asking themselves a day after Facebook filed its S-1 IPO prospectus with the Securities and Exchange Commission. The social network boasts an impressively large--and engaged--user base. Yet the company hasn't fully figured out how to make money off of them.

Investors will be clamoring to get ahold of Facebook stock, with many hoping to get in before the company figures things out and the stock takes off.

"I think Wall Street's reaction will be quite positive," said Timothy Loughran, a finance professor at Notre Dame. "Lots of investors want to own Facebook."

The asset that Wall Street is primarily looking at is the user base. More than half of the 845 million monthly users actually log in to the social network on a daily basis.

The result has been impressive growth in its top and bottom lines. In 2011, the company saw revenue double to $3.7 billion, while its profit grew 65 percent to $1 billion. Over the past two years, its revenue rose nearly fivefold, while its profit more than quadrupled.

"The numbers show clearly that not only is social media not a passing fad, but there's some real money to be made here," said Michael Gartenberg, an analyst at Gartner.

Facebook already overvalued?
Facebook's current financials and fundamentals look solid, but there are questions about its future, said Trip Chowdhry, an analyst at Global Equities.

The financial figures don't look so rosy to everyone. Loughran noted that its revenue figure equates to roughly $4.39 per active user, which he said was surprisingly low. Assuming that revenue-per-user figure remains constant, if Facebook gets to $3 billion users, it will only be able to generate $13.2 billion--an impressive amount, but not one that justifies a $100 billion valuation.

"That strikes me as a bit expensive given that Facebook already has a sizable percentage of the Earth's population as active users," Loughran said.

Chowdhry said that the company should be valued closer to $50 billion to $60 billion and that investors wouldn't see much return if they bought in above that level.

It's about the platform
Still, others are more optimistic that the company will be able to generate more revenue per user down the line. One analyst, who didn't want to be named because his firm hadn't cleared him to talk about the IPO, said a lot of the potential comes from Facebook's position as an app platform.

Facebook's finances

Facebook has finally opened up its books. What do you think?

FarmVille and Words With Friends maker Zynga is Facebook's single biggest contributor of revenue, chipping in 12 percent of the total in 2011, according to the filing. But the potential lies in different apps, services, and business models running on top of Facebook--pieces that go beyond social gaming.

In this instance, Facebook won't be in the lead, but will help foster the development of these new apps, the unnamed analyst said. He believes the "opportunities are immense."

Facebook noted in its filing that it doesn't yet run display ads in its mobile app --a problem because an increasing amount of people check in on Facebook through a smartphone app. But that could also present an opportunity down the road as the company taps into another possible revenue stream.

For all of his concerns, Chowdhry acknowledged that Facebook's ability to innovate on new services and business models has already been impressive.

Challenges to monetization
Facebook will have to tread lightly if it wants to generate more revenue from consumers, which will in part include more ads. There's the risk that the increased number of ads will clutter up the site and turn users off. How Facebook navigates that issue while boosting its revenue growth will be something Wall Street will need answered.

"Facebook needs to be very careful," Gartenberg said. "An unhappy user is not an engaged user."

That's a problem MySpace encountered as it began to post more ads and lose control of the look of its site, leading to Facebook usurping it as the leading social network. Chowdhry warned that the same thing could happen to Facebook if it pushes ads too aggressively.

There's already an alternate social network in place: Google+. While Facebook is by far the world's largest social network, Google+ has made big strides since its launch in June.

Facebook, meanwhile, will need to figure out how to run ads on its mobile app if it wants to make any money in that area--which is key as people spend more time on their mobile phones than ever before. But given the small screen real estate, it's unclear how it can deliver ads without irking people.

Facebook relies on customer data and preferences, which is less useful to advertisers than the search-based data that Google offers. By its nature, a search suggests immediate user interest, which is more valuable to an advertiser. As a result, Facebook can't get the same kind of advertising dollars that Google commands. That could change if it goes into the search business itself.

The ultimate gauge of Facebook's value won't occur for another few months, when its stock gets its initial public offering. Until then, analysts will privately mull over the numbers as the company goes on a road show to drum up investor interest.

It could be a long few months.

About the author

Roger Cheng is the executive editor in charge of breaking news for CNET News. Prior to this, he was on the telecommunications beat and wrote for Dow Jones Newswires and The Wall Street Journal for nearly a decade. He's a devoted Trojan alum and Los Angeles Lakers fan.

 

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