[BBC] Facebook’s IPO - it’s up to you

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"If you're not paying, you're not the customer, you're the product." This warning to Facebook's 800 million users about the nature of the social network's business model has become something of a cliche. But, as the world awaits the most hotly anticipated IPO since Google, it's clear that what will be on sale is you, the user, and your 800 million friends. (With half of the UK population on Facebook, I'm assuming that you're likely to be a member.)

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How much we are deemed to be worth is what will determine the value of the business when the shares are priced. Facebook, like Google, is an advertising business and one that has introduced a radical new way of reaching consumers. With Google it was via our searches, with Facebook it's our likes, dislikes and all the other data that we contribute freely to the site.

Ask anyone about adverts on Facebook and they are likely to tell you that they never notice them, and are sure they have no impact on their purchasing decisions. They are quite likely to say the same about the ads served up by Google, yet the search firm's clients are happily handing over billions of dollars, confident that this is the way to reach their customers

On a visit to a London digital marketing agency yesterday, I got a glimpse of how powerful a platform Facebook can be for advertisers. I-Spy demonstrated how they could funnel into Facebook's data to target a precise group of people - say, 25-40-year-olds in the Reading area, looking for jobs in the technology sector.

The agency, which used to send nearly all of its clients' marketing budgets in Google's direction, is now putting about 10% on Facebook, and expects that to grow. Jim Brigden, I-Spy's CEO, was enthusiastic about what the social network could offer in terms of targeting, but cautious about whether it would ever be as useful as Google.

He explained that Google delivered customers who were already looking for something, while Facebook might be better for engaging with consumers and letting them know about a brand. "It won't work for everything," he said. "You wouldn't try to sell funerals or financial services." But his clients, from a recruitment agency to the makers of Spam (the real thing, not that stuff in your inbox) were very happy with the results so far.

What we will find out when the IPO papers are filed is just how much revenue this kind of advertising is earning for Facebook, and how rapidly that is growing. Then Wall Street will have to decide how to price the shares. Last week they were trading privately at a valuation of $80bn, and there is talk of the price tag climbing to $100bn or above.

That figure looks ridiculous for a business with much to prove, but optimists will say that there was similar scepticism about Google's IPO in 2004. The search firm went on to show that it was worth a whole lot more than the value at which it floated.

Whatever the price, the Facebook IPO will generate eye-watering sums for investment banks, lawyers, and of course Mark Zuckerberg and other owners of a slice of the business. Then the really difficult bit starts - showing that the Facebook audience really is a valuable resource, willing to be targeted with more and more advertising. In other words, it is up to you and your Facebook friends.

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What kind of revenue does Facebook generate? Facebook's 2011 revenue was only about $3.7 billion but net income was about $1 billion.  About 90 percent of revenue came from display ads with the remainder from games from its partner, Zynga, played on Facebook. By comparison, Google reported 2011 revenue of $37.9 billion, up 29 percent, while Yahoo reported revenue fell 21 percent, to $4.98 billion.

How "sticky" is Facebook and what kind of revenue is generated from advertisers? eMarketer, a research company, estimated Facebook's 2011 revenue was $4.27 billion, with 88 percent derived from advertising.

Given that Facebook has 845 million accounts, the revenue figure looks low. Per-user revenue was about $5.10 last year, based on the average of 725 million users. Google generates $27 per user!

Comscore, another researcher, reported Facebook's share of the 2011 market for display ads rose to 27.9 percent from 21 percent in 2010. Yahoo had about 11 percent, with both Google and Microsoft holding  below  5 percent shares.

Facebook detailed how many daily clicks are generated from its users, especially the heavy ones, as well as specified some of its traffic. Still, whatever value is pegged for its shares, it will have to reflect some of these numbers.

Google shares, trading Thursday  at $580.83, value the Mountain View, Calif.-based company at $188.8 billion. Their price-earnings ratio is 19.51.

Yahoo shares, trading at $15.73, value the Sunnyvale, Calif.-based company at $19.5 billion and a price-earnings ratio of 19.19. Of course, given Yahoo's recent history, investors including Daniel Loeb's Third Point Capital, believe Yahoo's current price masks billions of untapped assets in foreign investments.

By contrast, shareholder Microsoft's market value is $250 billion and its price-earnings ratio is 10.82.

Facebook, if it were to raise $5 billion in the IPO, would have a market value of $100 billion. But if its annual income is only $1 billion, its price-earnings ratio would be a lofty 100 percent!