The Great Facebook Profitability Question

by Jonathan Berr | January 30, 2012 12:26 pm

Hate to bust your bubble investors, but Facebook, whose much-anticipated IPO[1] may finally be arriving, may not be earning much if anything in the way of profits.

The pioneering social network has grown from an amusing online diversion to a vital part of modern communications since Mark Zuckerberg founded the site in his Harvard dorm room in 2004. According to media reports, Palo Alto, Calif.-based Facebook wants to raise as much as $10 billion from investors, a deal that places a value of between $75 billion and $100 billion on the company. The IPO would happen between April and June, according to The Wall Street Journal[2].

The Facebook stories are chock full of details — indicating that the leak was planned — including the fact that Morgan Stanley (NYSE:MS[3]) was expected to take the lead on the deal and not, as many assumed, Goldman Sachs (NYSE:GS[4]). Acting if Goldman were a child whose feelings needed to be protected, the anonymous sources who are gabbing to the Journal added that the investment bank was playing a “major role” in the IPO, whatever that means.

In September, eMarketer[5] estimated Facebook’s 2011 revenue at $4.27 billion, more than double 2010. But such a figure is irrelevant without details on costs, which are no doubt huge. CNBC[6] reported Friday that “the company’s expected to earn about $3.8 billion in 2011 full-year revenue and roughly $1.5 billion in operating profits.” ZDNet[7] questioned those numbers but still figures Facebook is profitable.

So, give the Journal credit for at last saying it isn’t known yet if Facebook is profitable. Most other news sites don’t even mention the “p” word even though it is hugely important.

Investors eager to score shares of this landmark IPO need to remember that Zuckerberg may not be your kind of CEO. He clearly isn’t looking for a quick payday or else he would have sold his company to Yahoo (NASDAQ:YHOO[8]) or Microsoft (NASDAQ:MSFT[9]) years ago. Like his counterparts at Google (NASDAQ:GOOG[10]), the Internet wunderkind thinks over the long term. Quarterly earnings may not interest him much. While that may be great for Facebook, it may result in a stock prone to erratic swings.

If Facebook were profitable, it seems one of Wall Street’s many anonymous sources would have said something to the press. That would be too good of a tidbit to keep quiet, especially considering the poor performance of some recent IPOs of money-losing companies.

LinkedIn (NASDAQ:LNKD[11]) reported a third-quarter[12] loss of $1.6 million, and Groupon (NASDAQ:GRPN[13]) lost more than $220 million in the first half of 2011. Both companies’ shares are down more than 20% over the past six months. Yelp filed to go public in November even though it reported that it lost $7.6 million in the first nine months of 2011.

As cool as Facebook is, it isn’t cheap to operate. The company’s website[14] says it has more than 3,000 employees at offices around the world, from Atlanta to Venice Beach, Calif., and from Dublin, Ireland, to Hyderabad, India. Let’s not forget its global network of data centers stocked with custom-designed servers needed to service Facebook’s 800 million users.

“Initially, as most Internet startups do, we leased data center space alongside other companies in the same building,” wrote Jonathan Hellinger, a Facebook executive, in a 2010 blog post. “As our user base continued to grow and we developed Facebook into a much richer service, we reached the point where it was more efficient to lease entire buildings on our own. We are now ready to build our own.”

Facebook’s spending on a site in Oregon supported approximately[15] $142.7 million in economic activity and 1,081 jobs, according to a study. Another server farm is being built near the Arctic Circle in Sweden[16]. It isn’t clear how many servers are needed to keep Facebook running, but they aren’t cheap. Google recently announced it spent $951 million on servers in the fourth quarter.

Most individual investors have no chance of getting in on this IPO. The best strategy for most people is to wait for the shares to crater when the company fails to meet Wall Street’s lofty expectations. It will happen eventually, as it has since the dawn of time.

Jonathan Berr, who doesn’t own any shares mentioned here, will be watching the Facebook IPO from the peanut gallery.

Endnotes:
  1. much-anticipated IPO: http://investorplace.com/ipo-playbook/facebook-public-offering-10-biggest-ipos-in-history/
  2. according to The Wall Street Journal: http://online.wsj.com/article/SB10001424052970204573704577187062821038498.html
  3. MS: http://studio-5.financialcontent.com/investplace/quote?Symbol=MS
  4. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  5. eMarketer: http://www.emarketer.com/PressRelease.aspx?R=1008601
  6. CNBC: http://www.cnbc.com/id/46167056
  7. ZDNet: http://www.zdnet.com/blog/facebook/facebookss-2011-revenue-and-profit-numbers-leak/8153
  8. YHOO: http://studio-5.financialcontent.com/investplace/quote?Symbol=YHOO
  9. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT
  10. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  11. LNKD: http://studio-5.financialcontent.com/investplace/quote?Symbol=LNKD
  12. reported a third-quarter: http://www.forbes.com/sites/tomiogeron/2011/11/03/linkedin-q3-earnings-revenue-of-140m-beat-street-but-stock-down-after-hours/
  13. GRPN: http://studio-5.financialcontent.com/investplace/quote?Symbol=GRPN
  14. The company’s website: http://www.facebook.com/press/contact.php#%21/press/info.php?factsheet
  15. Oregon supported approximately: http://www.cascadebusnews.com/news-pages/e-headlines/1814-facebook-unveils-economic-impact-study
  16. Arctic Circle in Sweden: http://www.telegraph.co.uk/technology/facebook/8850575/Facebook-to-build-server-farm-on-edge-of-Arctic-Circle.html

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