It’s not all that often that a era-defining initial public offering comes along. In the next few weeks Facebook is set to go public amidst a great deal of talk that there is a “bubble” in Silicon Valley. The Facebook story is more than the question of whether you should try to get in on the IPO. It really puts a stamp on the Web 2.0. Veteran journalist Nancy Miller is covering the Facebook story in depth via her e-book The Facebook IPO Primer which also happened to get a positive review from David Merkel at the Aleph Blog.
Admittedly the vast majority of individuals and institutions who put in for shares in the Facebook ($FB) IPO will likely get shut out, but that doesn’t mean there aren’t lessons to be learned along the way. In light of the start of the Facebook road show next week I asked Nancy a series of questions about the Facebook and its coming offering. You can read part one of our discussion. With no further ado here is the second part of our Q&A.
AR: Nobody is really sure how to value social media companies in general, and Facebook specifically. What metric(s) should investors pay attention to more than others?
NM: A great question. These days, the most important metric is something I would call the DNA meter. The DNA meter is a combination of gut and factual observations about a company and its basic make-up. Today, companies like Facebook need a high quotient of mobile in their DNA. The DNA meter is a concept that has been brewing quietly over the past couple of years, but from what I see, the concept is suddenly overrunning high tech. Now you have people like Eric Jackson at Ironfire Capital saying that Facebook and Google might be has-beens in the next five years or essentially because they don’t have the right kind of DNA. Jackson put in terms of an ecosystem. Web 1.0 was one system. Web 2.0 antoher. Now Mobile is yet another. This is a way of saying their big growth is over.
The DNA meter is far from infallible. Look at IBM – there’s a company that knows how to re-invent itself. And even stodgy old Microsoft is doing some impressive high-kicking — look at the Nook deal. Pretty awesome stuff.
But the DNA meter is valuable because it pinpoints the critical weakness in any enterprise. Two years ago former Wedbush analyst Lou Kerner wrote that Wal-Mart online would never be successful the way Amazon is successful because it has the wrong DNA. Today, some are saying Facebook doesn’t have the right DNA for a mobile world. Its roots are desktop.
If the DNA meter says you’re a has-been, then all the traditional measures of growth and earnings power lose their potency. But if the DNA meter says you’re made of the right stuff, then the next metric I would look at is revenue growth, the golden standard for young companies. So when Facebook reported the slowdown in revenues, it became freak-out time. Most analysts say pay no attention to price/earnings ratios. Earnings will come after revenues. That’s the LinkedIn story. Its 2012 p/e is ridiculous, about 170x, depending on the estimate. But its market cap is trading at nearly 13x the estimated 2012 revenues, which feels a lot more comfortable to investors who are betting on big growth ahead. Presumably, the growth will translate into robust earnings.
LinkedIn is growing at a faster rate than Facebook – in part because its smaller – so some analysts say Facebook should trade at a slight discount to the market cap/revenue ratio of LinkedIn. So let’s see what that means for Facebook. A number of analysts have sharply ratcheted down their revenue expectations for Facebook — as low as $5 billion from $3.7 billion in 2011. Before Facebook reported its first quarter results, everyone was talking about a valuation for the company of $75-$100 billion. If Facebook prices at $100 billion, then it would trade at 20x revenues. That’s pretty high. Even if you are really optimistic about what lies ahead, and stick to a high end estimate for revenues of $7 billion, that ratio would still be a hefty 14x.
In social media, there are two other key measures, closely linked to one another: users and user engagement. These numbers are important but squishier. Facebook has 901 million monthly active users, up 33% from a year earlier – that’s nearly half of all Internet users. Daily active users are growing even faster, up 41%. Mobile users jumped 69%, and are the most important part of the new growth for Facebook.
I say those numbers are squishy, because no one knows how many people have more than one account on Facebook (even though it’s against the rules). Facebook says it believes the number is just 5%, but who knows? That’s clearly a guesstimate. A lot of people laugh at the definition of a user. You can open your account by accident and that gets counted as a user.
That’s where the engagement measurement comes in. How long are users staying on Facebook? And the answer to that is pretty positive: In the lingo of marketers, Facebook is getting stickier. According to comScore Media Matrix, the average number minutes that a user stayed on Facebook In January 2012 increased by 14%; total minutes zoomed up 57% to 10.2 billion per day. That is pretty incredible. And really important to advertisers.
This leads me back to the DNA meter. When it comes to mobile, the meter is pretty close to zero. Now for some analysts, that means the potential is huge. Arcstone Equity Research takes a look at the metrics and sees huge potential. Google outearns Facebook 5-to-1 in terms of ARPU but Facebook engagement is deepening. After the SEC released the latest amendment to the Facebook IPO filing, I spoke to Kevin Landis, who owns 600,000 shares in his Firsthand Technology Fund. He was just shaking his head over the reaction. The revenue news wasn’t great, but he said the numbers showed that Facebook was getting more traction in mobile, and that’s where the action is. As he put it to me: “Growth comes first, money comes second.”
For more on the Facebook IPO check out Nancy’s e-book and stay tuned for part three of our discussion.