It’s hard to think of an initial public offering that’s had as much hype as Facebook’s since, well, Google’s. Understandably, everyone’s comparing the two, and it’s a flattering comparison for Facebook. Google’s IPO shares went for $85; today they’re selling for $585 a pop.
But Google did two important things: it monetized well and it grew—a lot. Can Facebook follow in those footsteps? Well, not all high profile tech companies are created equal. Google was a good investment, but Facebook is not Google.
While Facebook in 2011 generated US$3.7 billion in revenue with a profit margin of US$1 billion, its market cap is estimated to reach upwards of US$100 billion. That means it could wind up with a price-to-earnings ratio of 100. Can Facebook really grow enough to justify that?
Mike Moffatt, an economist at the Richard Ivey School of Business, is among the skeptics. The only argument you can make to justify Facebook’s valuation, says Moffatt, is based on Google’s success. “Because it’s not based on the business model,” he explains. Facebook now has 845 million users, and considering that planet Earth only has 7 billion, that’s not bad—but it also raises the question: where do you go from there? Sure, Facebook is growing in markets like Japan, but the walls are nonetheless closing in on the company, which is precisely why growth rates are, in fact, slowing.
In Facebook’s S-1 filing, the company points out that there are presently 2 billion active Internet users, adding that “we aim to connect all of them.” The statement rings overly optimistic. The company explains that there are a handful of big countries its yet to break into—for example, they say “in China, where Facebook access is restricted, we have near 0% penetration.” But even if restrictions eventually relax and the Chinese are smitten with Zuckerberg’s social network, the company won’t have grown nearly to the extent that Google has.
For that, Facebook needs better monetization and growth into new products. “They’re going to need to expand this into something else,” says Moffatt.
Which raises another question: Is Zuckerberg the right man for this particular job? His goal has always been to build the best social network—not necessarily a multibillion-dollar company with a large roster of products. But for investors, “there’s simply not enough ad revenue there,” explains Moffatt. Then you look at Google, which “has 10 times the revenue and more growth potential.”
Now, if this were 2007, Facebook’s estimated P/E ratio might be justified, he adds. But in 2012, Facebook is a pretty mature tech company, one that’s already done a lot of its growing. This is a late IPO. Meaning that in order to justify its gargantuan market cap, Facebook has to become a new type of company. It needs to do what Google did and expand well beyond its core product.
Zuckerberg might not be the right man to do this, but no doubt massive growth is what long-term investors want. Or expect. Meanwhile, Facebook has a brand name that doesn’t really make sense applied to anything that’s not Facebook. While it’s true that I once thought of Google as search engine first (Google now makes me think of the company), Facebook has a name that quite literally describes the product. That’s a real branding challenge when one wants to swim in new waters. Moffatt agrees. “I’m not sure how they get around that hurdle,” he says. Let’s say they open a music store, “do they just start calling it Facetunes—do what Apple did and throw i in front of everything?”
Facebook has yet to expand like Google did, and maybe that was never the plan. But when you go public, things change, and investors will be putting money into a company they believe is going to grow a lot. They may be picking the wrong one.
Moffatt describes it as “irrational exuberance. We’re so dying for a big IPO, because we haven’t had one in years,” he says. Sure, IPOs in general tend to underperform the market, but “Facebook is taking that to the next level.”