Even a dotcom analysis requires heroic assumptions about future revenue growth to get near to the valuation ascribed to the company before the price range was increased, says Alan Patrick, co-founder of technology consultancy Broadsight. There are so many unanswered questions: how to make money from mobile [the issue addressed in the supplement to the prospectus] being just one of them. Victor Basta, managing director of technology M&A advisory firm Magister Advisors, points out that Facebook will have to grow to $30 billion to $40 billion in revenue to justify its current valuation. It cant trade at 30 times revenue forever, he says. Where will that revenue come from? A seventh of the world might use Facebook, which theoretically gives it scope for subscriber growth. But much of the remainder of the world especially in developing countries doesnt have a PC or a smartphone. Moreover, many of those people dont have a life that takes them outside their village. They dont need Facebook. However, Daryl Jones, head of research at Hedgeye Risk Management, points out: Facebook created a new industry and has succeeded in monetizing it in just a few years from advertising but partly by collecting fees from app companies, specifically in the sale of virtual goods again an industry that did not exist until recently. To value the firm on short-term metrics is short-sighted. Facebook will create new revenue streams like it did with apps. We just dont know what those are yet and maybe nor do they. But with 500 million users a month and those user numbers increasing, Facebook doesnt have to make a lot of money out of each customer to justify its roughly $100 billion valuation. Just creating some new products to sell to that massive user base will lead to exponential cash flow. Concerns about whether Facebook will be able to make money from the shift into mobile are also overplayed, says Jones. The average Facebook user spends eight hours a month on it on their desktop, he says. The average Facebook user who uses both mobile and desktop spends 12 hours a month on the site. So, it may be harder to sell ads through mobile at the moment, as no one has worked it out yet, but the move to mobile also means Facebook has stickier clients so an even stronger user base. Basta emphasizes that if Facebook is not going to fill its revenue gap through growth, it must fill it by getting more from existing users. However, this model also presents challenges, says Basta. Facebook depends on partners to a far greater extent than Google, for example, did at a similar stage of its development. Google was much more of a silo company, whereas Facebook depends on its ecosystem of partners. Facebook has the advantage it can charge other companies for being on its platform. However, the flip side is that it has to give everyone a cut of its business. The excitement generated by Facebooks IPO was understandable, but once stories emerged of parents punting their childrens college funds on the IPO, a social network bubble began to form, according to Patrick. The parallel is with 1995 and Netscapes IPO: the dotcom madness hasnt arrived but its on the way, he says. Other social network-type businesses will try to list and the wisdom of crowds will become the madness of crowds: people will just want to be part of the next big IPO. Given such a fever, it might have been responsible to stick to the original deal size and range, and let the aftermarket do its work. Instead, the underwriters increased the price and inflated the deal by a quarter: Goldman Sachs more than doubled the number of shares it planned to sell, from 13 million to 29 million, Silicon Valley investor Peter Thiel increased his sale from eight million to 17 million shares and hedge fund Tiger Global increased its sale from three million to 23 million shares.
Of course, Facebook might yet end up as the worlds most successful company and its valuation become fully justified. However, coming so soon after JPMorgans European credit-default-swap debacle demonstrated that recklessness is still rife at some of the worlds global banks, a touch more humility and a bit less of a throwback to dotcom days might have been welcome in bringing Facebooks IPO to market.