The $100 Billion Facebook Question

Facebook’s long-awaited initial public offering filing has landed, and the company is likely to see the largest market debut ever. And while retail investors are expected to gobble up Facebook shares, experts at Wharton point out that there is no guarantee the social network giant will be a long-term winner on the stock market.

First of all, it’s unclear whether Facebook can grow into its estimated valuation of roughly $75 billion to $100 billion, says Luke Taylor, a Wharton finance professor.

On the surface, Facebook, which will trade under the ticker FB, looks like a juggernaut. The company has 845 million monthly active users, who contribute 250 million photo uploads and 2.7 billion comments a day. The company’s financial picture also looks good. For the year ended December 31, Facebook reported net income of $1 billion on revenues of $3.71 billion. In 2010, the firm saw net income of $606 million on revenues of $1.97 billion.

It’s not certain when Facebook will actually go public, but press reports estimate that late April or May is a likely target. Taylor notes that Facebook’s debut prospects will largely depend on how the Nasdaq trades and other market conditions. (The Nasdaq index is often viewed as a proxy for the tech industry.) How will the company’s shares trade ultimately? Facebook is likely to capture the imagination of retail investors, but so-called “smart investors” may pare back demand. “It’s not automatically true that Facebook will soar,” Taylor points out.

What will Facebook’s long-term profits look like? According to Taylor, companies often show strong profits heading into an IPO, but then they drop afterward. He adds that there is a lot of debate about whether the profit drop is related to less innovation or just the higher expenses that come with being a public company. In its IPO prospectus, Facebook cites Sarbanes-Oxley compliance costs as a potential profit margin hit.

Another pitfall would be what Taylor calls “short-termism.” Managers of newly public companies “often become myopic and focus on short-term numbers. That’s a risk of going public.” In a previous Knowledge@Wharton story about Facebook’s future on the open market, Wharton management professor Lawrence Hrebiniak cited a similar risk. “The challenge for Facebook will be to keep top executives focused on strategy and not regulation.”

In a letter to potential shareholders, CEO Mark Zuckerberg noted that “Facebook was not originally founded to be a company. We’ve always cared primarily about our social mission, the services we’re building and the people who use them. This is a different approach for a public company to take.”

Lastly, the company may feel the effects of management turnover, as some managers cash out and the leadership team looks to hire seasoned executives to help steer the company while it matures. “Facebook’s IPO will be a massive liquidity event for thousands of employees,” Wharton legal studies and business ethics professor Kevin Werbach said in the Knowledge@Wharton article. “Many of them have already monetized at least some of their stock options through private secondary market activity, but the IPO will still be a massive wealth transfer. It’s difficult to retain employees who have already made millions of dollars on their stock options.”

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