Facebook IPO: Is a $100 Billion Valuation Cool?

One of the most anticipated events in .com history is finally upon us: Facebook has filed for its Initial Public Offering (IPO) and everybody is speculating about how high the company’s valuation will go.

We asked a couple of experts to shed some light on the matter: Professor Mark T. Leary, of Olin Business School, believes that at IPO the firm will have a total market value in the $80 – $100 billion range:

“I don’t doubt that investors will be willing to pay that price for the shares, based on the valuations coming out of their past private issuances and recent online auctions for private shares,” he says.

But just because people are willing to pay that price, does it actually mean that Facebook is worth that much?

Leary stresses that both Google’s and specially Facebook’s valuations require pretty aggressive assumptions about future cash flow growth.

“From a simple cash-flow growth model, a $100 billion value would imply that investors expect Facebook’s cash flow to grow forever at just 1% less than their cost of capital, which is probably around 10%. 

In the short run, they are sure to grow faster than that, but it’s hard to expect them to maintain that pace as the company grows and matures.”

Google holds the record for the largest U.S. Internet IPO by raising $1.9 billion at a valuation of $23 billion in 2004.

At that time, Google’s market value was about $50 billion, but their revenues and cash flow were lower than Facebook’s are now, by about 15% and 30%, respectively.

Google’s ratio of market value to free cash flow at the end of 2004 was about 87.

Applying that to Facebook today would give a value about $80 billion.

So $100 billion might still be a stretch, but $75 or $80 billion does not seem out of line given the way the market has valued Google.

Facebook says it hopes to raise as much as $10 billion when it begins selling shares this spring; Among U.S. companies, only Visa Inc., General Motors Co. and AT&T Wireless have held larger offerings.

Its success, according to Leary, will depend on how aggressively the investment bankers price the issue and how broadly they allocate shares.

The harder thing to predict, however is how the stock will do in the long term.

“Some of the key factors in that regard will be their ability to convince advertisers to spend more money trying to reach their large user base, and their ability to continue to provide innovative services in order to both attract new users and increase the amount of time each user spends on their site.”

“I think Facebook has a more sustainable competitive advantage,” says Leary.

“With social networking, there’s a big advantage to being the first one to attract a large user base; That is, a networking site is only attractive to use if others are also using it.”

Jessica Powell, CMO of Badoo

Jessica Powell, formerly of Google and now Chief Marketing Officer at social network Badoo, agrees that it is important to achieve critical mass:

“Badoo is the largest social network in the world dedicated to meeting new people, and we currently have over 138 million registered users.

Once you get to that size the value of your network grows exponentially because in people have thousands of potential new friends online at any given time.”

Some people look at these sky-high valuations and wonder whether we are seeing a second Internet bubble, but Leary says there is more substance to companies like Facebook and their business model:

“The Internet itself is a more established advertising medium than it was in the late 1990s, and there is less uncertainty about the total size of the market, but I think this model is only viable for the ‘winners’ in capturing online share.

One key difference is that they are already profitable. 

At the height of the Internet IPO craze in the late 90s, you couldn’t even talk about price-to-earnings ratios since most firms that never turned a profit. 

So investors were buying on speculation both about the site’s ability to generate user growth as well as their ability to translate users into profits.”

But not all social networks choose to go down the advertising route: Like LinkedIn, Badoo thrives on a Freemium model which offers most services for free but sells greater functionality and visibility through premium accounts and micropayments.

“Advertising on mobile can be a real challenge for social networks given the screen size, and issues around format and engagement.

That’s in part why we opted for a freemium model, which allows users to get extra functionality through micropayments.

Over one million payments are made on Badoo every month, so it’s proving to be a successful model for us,” says Powell.

IPOs are often criticized for reducing innovation once the firm becomes public,” Leary points out.

“This is likely to be less of a concern for Facebook, since they’re actively guarding against it. 

For example, their dual class structure ensures that current insiders, particularly Zuckerberg, will maintain the majority of the voting rights after the IPO.”

Alice Bonasio is a Brazilian/American/Italian writer specializing in Digital Cultures. She has been published in Gamestm, Edge, The Escapist and 360. She is currently finishing an MA in Creative and Media Enterprises at the University of Warwick. She lives in England and is a PR Executive for one of the UK’s hottest tech start-ups, The Filter. Contact her on LinkedIN and follow her on Twitter.

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