– Facebook S1 reveals sales a bit lighter than many thought, but very strong margins
– The addressable market could be huge IF Facebook decides to go after it
– Zuckerberg’s letter reveals his indifference to short term profitability
So Facebook finally filed its S1, filled with titillating financial tidbits and blog fodder. All signs post to full subscription at a robust final deal price, with anticipation building over many, many months of Zuckerberg footdragging and displaced enthusiasm driving interest in imperfect Facebook surrogates like LinkedIn and Groupon. On some day, in April or May, investors will finally get their chance.
What will they be buying? First, and foremost, Facebook is a company of enormous potential. We have written extensively about the opportunities potentially addressed by the leaders of the consumer cloud. (See LINK) The addressable market numbers are staggering – $4 trillion in brick-and-mortar retail sales, $1.5 trillion in advertising, $300B in traditional media, $150B in financial transaction fees, $100B in consumer services, and so on, and so on. Against that, Facebook has established a massive global base of 850 million active and loyal users with substantial switching costs that it has only just begun to try to monetize. Facebook is generating less than $4.50 per year in revenue from each of its users, mostly from advertising, where it is less than 10% the size of its supposed rival, Google, which generates more than $30/year from its users. Facebook’s 88% YoY sales growth rate suggests that gap is much more a function of the company’s relative youth than to any lack of opportunity.
Facebook is also an outstanding software company with an extraordinary distributed data processing infrastructure. The company manages one of the world’s largest data bases, allowing a truly global base of 850 million users to make unstructured queries against a staggeringly deep array of user managed information, all at near lightning speed. This, of course, requires IT talent, which the company has in spades, and infrastructure, on which it is spending at a breakneck pace. Despite the massive investment requirements in human and physical capital, Facebook is enviably profitable, delivering 27% net margins.
Of course, it is not a given that Facebook will execute against the opportunities in front of it, or even if the company will make the effort at all. Google and Amazon investors will testify to the frustrations of owning stock in companies run by well insulated billionaires who care more about long term growth than about near term profit. Arguably, Facebook is likely to be even more frustrating. Post IPO, Mark Zuckerberg will still control 57% of the voting stock of the company. He reportedly only decided to go through with the IPO after learning that Facebook would have to file financial statements anyway as the total number of investors tipped above the 500 limit. His letter to investors is a straightforward warning – “Simply put: we don’t build services to make money; we make money to build better services.” In a quarter where both Amazon and Google blindsided their investors with disappointing results, Zuckerberg is indicating his own indifference, should Facebook feel the need to do the same someday, so be forewarned.
In the end, I think that Facebook will probably turn out to be worth the frustration, but there are some significant strategic hurdles to be breached, many of which are duly noted in the risk section of the S-1. It does not have a platform at the device level, and must depend on Apple, Google and Microsoft to deliver its users, giving these rivals the first crack at addressing the commerce, advertising, and media opportunities. Its historically aggressive stance on user privacy could put it in the crosshairs of regulators in many geographies. It has been curiously passive in pursuing paths to monetization and it faces stiff competition for most of the most obvious opportunities. Investors loved Facebook when it was a mystery that they couldn’t buy. It will be curious to see whether they are nearly as enthusiastic once the door is open.
For our full research notes, please visit our published research site.