Facebook’s initial public offering
Facebook will float on the stock exchange, and speculations are that the company’s market cap will end up at USD 100bn. With a price tag of this magnitude Facebook will move straight into the top league of Internet stocks which includes Google (with a market cap of USD 190bn), Amazon (USD 83bn.) and eBay (USD 42bn).
It is estimated that more than one billion people around the world will have a Facebook profile by the end of the year. The customer base has swelled to this size in no time, considering that Facebook was launched in 2004. The company has thus gained a very important first-mover advantage compared to other social networks on the Internet.
Facebook hard to beat
Facebook’s business model has so-called network effects. This means that the value of the Facebook network rises exponentially with the number of users of the network. When new users are to decide what social network they want to join, many choose Facebook – for the simple reason that the number of existing users of this network is the highest. These network effects make Facebook virtually unstoppable and undefeatable. Google has tried to launch a competing product alternative, Google+, so far with limited success but one should not underestimate Google. Its R&D costs amount to well over USD 1bn per quarter!
Facebook must demonstrate its ability to make money
Facebook is thus already a great success, but this does not necessarily mean that you should buy the stock. Even if Facebook can boast a large number of users, they have so far only generated limited earnings for the company. Last year Facebook reported a profit of USD 1bn. If its market cap ends up at USD 100bn, this means that you pay USD 100 for a USD 1 profit. A valuation at this high level would require substantial earnings growth in the years ahead for the stock to be worth buying. Facebook will have to become really good at making money on its large number of users.
Over time, user subscription could become an option, but the question is whether the users will accept it, especially if other alternatives such as Google+ are available. Though we hesitate to say it’s impossible, the odds are that it will be difficult for Facebook to make a sufficient profit on its users to justify a price tag of USD 100bn.
Michael Borre
Chief Adviser
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