The hottest stock on the block could have a hefty price on it, writes Nathan Field.
In case you hadn't heard, one of the most anticipated floats in recent history is likely to come to market this year. And no, it's not Mighty River Power. Facebook, already the stuff of Hollywood movies, is gearing up for an initial public offering (IPO) that will add a new chapter to the social network's story.
It's easy to see why investors are excited. Along with Google, Apple and Amazon, Facebook is at the forefront of the consumer revolution on the internet. Early guesstimates put the company's value at as much as US$100 billion ($124 billion). That would make it bigger than established corporate giants Disney, Goldman Sachs, Visa, even McDonald's. No wonder the Winklevoss twins are still upset.
The excitement's not just hot air. Some of the numbers around Facebook and social media sites are staggering. Facebook captures 55 per cent of internet users worldwide.
In the key US market, it has 75 per cent penetration. Even if the numbers are somewhat distorted by accounts registered under dead celebrities, garden gnomes, fifty-year-old men posing as teenage girls, and cats (lots of cats), there is no denying Facebook's global reach.
People are also lingering longer on social media sites, with the average time wasted per user growing at an annual rate of 25 per cent. While traditional mediums like TV and radio are seeing their audiences fragment, internet usage is becoming more concentrated among the most popular sites. In 2007, the top ten websites accounted for 43.6 per cent of total usage minutes. In 2011, the figure had grown to 47 per cent.
Facebook has been the biggest driver of this trend. In the space of four years, Facebook's share of total internet minutes has grown from less than 2 per cent to more than 15 per cent. Social media is pulling in eyeballs and holding them there, a point slowly being picked up by advertisers.
The wider online advertising market has been growing at double digit rates over the past five years, but it's still lagged behind the dramatic increase in internet usage and time spent online. As a result, some analysts believe we're about to enter a catch-up phase, as advertisers react more boldly to recent changes in consumer behaviour. While paid search (namely, Google) remains a dominant force in online advertising, the social media format arguably has a lot more room to grow.
Advertising isn't the only way Facebook can turn its popularity into profits. Its massive database means all avenues are open - retail discounts and deals, online commerce, and social gaming to name but a few. Like its three fellow rulers of the internet, Facebook is looking to build multiple revenue streams.
To date, Facebook has been pretty tight-lipped about its finances. Leaked estimates have put its 2011 revenues at close to US$4 billion and net income at US$1 billion. We won't know the details until Facebook opens its books, but the growth rates in sales and profits are likely to be pretty chunky.
So Facebook has to be the buy of the century, right? Ah, if it was only that easy. No one doubts the company has a glorious future ahead of it, but for investors in the float, there's a big catch. You will pay for this growth up front.
Even if the leaked numbers are a bit screwy, the fact that the market is talking about a $100 billion valuation suggests Facebook will initially trade on sky-high multiples - perhaps 50 times this year's earnings. Not the sort of multiple that would tempt a value investor like Warren Buffet, or perhaps any investor with a cautious bone in their body.
A second question is whether CEO Mark Zuckerberg and his pals are willing to pursue the kind of returns new investors will expect. Zuckerberg has previously stated that growing profits and keeping Facebook users happy aren't mutually exclusive, and there's some truth in that. But it's also true that users expect unlimited access to all the latest services and features, never want to pay a cent for anything, object to being intruded upon by ads and marketing campaigns, and want their personal details hidden from evil corporates. Making money from such a sensitive user base won't be easy.
And finally, there's the ephemeral nature of the technology industry. Not so long ago, everyone was logging into MySpace and Bebo. Can anyone really predict what sites will be popular in a decade. Or even how people will use the internet? Those investors who believe Facebook is a ten-year investment and are happy paying a lofty multiple up front are effectively answering yes to this question.
Good luck to them and their crystal balls. Technology valuations have a long history of optimism, bordering on insanity. Sometimes they're even proven right. And given that Facebook is still trending up, there will be no shortage of investors keen to buy the coolest stock on the block.
Nathan Field is a senior equity analyst at Gareth Morgan Investments, which holds investments in some of the mentioned companies on behalf of its clients.
Any opinions in this article are of a general nature and should not be treated as a recommendation or guidance to any individual. Everyone's financial circumstances are different, and readers should seek specific financial advice appropriate for their circumstances before making an investment decision.