Diary of an IPO: In Advance of the Facebook Roadshow: Five Questions for Mark Zuckerberg

Posted by on May 2nd, 2012

The Facebook IPO roadshow is scheduled to begin next week with the IPO slated for May 18. The Wall Street Journal said that Mark Zuckerberg might, and I highlight, might grace investors with his presence at some of the roadshow events.

This really troubles me – and it should trouble any and every institutional investor considering an investment in the company. It should also trouble every retail investor who thinks this might be his or her lifetime salvo.

As promised, I have reviewed the amended S-1 filing submitted on April 23, 2012. For those fortunate to attend the roadshow gatherings (I am still waiting for my invitation), here are five questions that need to be asked and answered before anyone should commit their hard-earned dollars to support Mr. Zuckerberg and the many pre-IPO investors who are looking forward to their liquidity event.

  • 85% of Facebook’s revenue in 2011 was generated from advertising and the rest from “payments.” This is more or less the same for the March 31, 2012 quarter. What is the plan to diversify the company’s revenue? And, please, be a little more specific than just suggesting “we will diversify.” A glimpse into a business plan would be helpful.
  • To this point, the company says that advertising on the social web, while undoubtedly a significant market opportunity, is still emerging and evolving and advertisers are still learning. To the extent that 85% of Facebook’s business is advertising based, how can a ~$100 billion valuation be justified without further explanation? For those of you crunching the numbers, this equates to a 33x advertising revenue multiple – Google only trades at a 5.5x advertising revenue multiple.
  • 11% of total revenue for the March 31, 2012 quarter came from Zynga. Based on your total revenues for the quarter, this would equate to approximately $116 million. Total revenue from the “payment” business this period was $186 million. Therefore, Zynga comprises 63% of payment revenue which means that only one-third of payment revenue is from others. If Zynga figures out its own solution – at some point why wouldn’t it? –revenue from payment would essentially disappear and Facebook’s entire business is almost exclusively based on advertising. What is the plan to change this?
  • Facebook has elected to be a “controlled company” under the corporate governance rules for NASDAQ since the company’s CEO controls a majority of the outstanding voting power. This means that the company isn’t required to have a majority of its Board be independent. It also means that it doesn’t have to have a compensation committee or independent nominating function. THIS IS A RED FLAG FOR EVERY INVESTOR. Is Mr. Zuckerberg trying to have his cake and eat it too?  Reap the benefits of being a public company and, at the same time, maintain the benefits of controlling a private company?
  • What other Instagram-style acquisitions are in the works? You need to shed light on what you mean when you say you plan to make frequent and rapid product decisions that may reduce short-term revenue or profitability even though they are consistent with your overall mission. How are we supposed to value Facebook based on so much uncertainty (or lack of clarity)? How do we value what it means when you say you will improve the aggregate user experience to improve financial performance over the long term?

I’ll say it again – I don’t want to be all doom and gloom. With a user base approaching 1 billion, there is no question that Facebook has the ability to grow in a big way. The issue I have is one of communications.

Yes the numbers will speak for themselves, but there is more to a company than numbers. It’s about the character and attitude of management, particularly the CEO. It’s about understanding a company’s growth plan beyond a moral vision. And, it’s about transparency in communications.  Without a full understanding of each of these, a proper valuation cannot be determined.

Stay tuned …