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Facebook IPO Update: Q&A with Smith’s Gerard Hoberg

May 12, 2012
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HobergGerardFacebook's recently disclosed price range for its initial public offering anticipated in mid-May indicates the company’s value as just under $100 billion. This development indicates the Internet giant now is well positioned to grow, said Gerard Hoberg, associate professor of finance for the University of Maryland’s Robert H. Smith School of Business.

Prior to the price disclosure, Hoberg discussed the Facebook IPO onMaryland Public Television. In this update, he discusses implications of the pricing, as well as the significance of Facebook going public.

How should investors react to the expected Facebook pricing?

Facebook set its expected price range to $28-$35 a share, indicating a valuation at $77 to $96 billion. This would make it the most valuable company to have an IPO in history. It is three-to-four times larger than Google's $23 billion valuation at the time of its IPO.

Facebook’s 2011 revenue was 3.7 billion, with profit close to $1 billion. If we consider the firm and ignore the IPO details, this effective price-to-earnings ratio in the 80s is high among publicly traded companies, but not uncommon among high growth firms. The valuation can be justified only if investors assume that Facebook can continue its rapid growth. A key challenge is that rapid growth is historically more difficult for a firm of this size.

Ways for Facebook to grow include increasing international penetration, improving the efficiency of its advertising by better matching target eyeballs to products they are likely to buy, and through innovative use of its enormous web presence. Facebook may challenge Google on some dimensions, which can be good (considering Google's success) or bad (as Google will not give up any market share without a fight).

A firm in this position is among the hardest to value, and there will be many experts and laymen alike who will disagree on the firm's true value.

If we consider the details of the IPO itself, investors should feel more relieved as Facebook has an all-star underwriting team including Goldman Sachs, JP Morgan, and Morgan Stanley among others. History shows that having the backing of such heavyweights usually indicates that the firm will do well, and the investment is at least a fair one. Such firms are risking their own reputation by backing this deal, and have much to lose if the firm does poorly.

Can retail investors participate in the Facebook IPO?

Facebook is doing more than most IPO firms to allow smaller retail investors potential access to its shares at the IPO price. Through firms like E-Trade, and perhaps some others, small investors might be able to participate in the IPO at the initial price. This may bode well for Facebook, as making retail investors happy is consistent with attracting more attention to Facebook's website, and in turn potentially generating more revenue. Given that buying shares at the IPO price is historically a better investment than buying in the aftermarket, this move will likely attract much attention and competition among retail investors to get access to what will likely be a limited number of shares, and so many retail investors may still feel shut out. Many retail investors may have only the option to buy on the aftermarket, and may have to pay higher prices. It is impossible to accurately predict whether their investments will ultimately be winners or losers.

Is Facebook reflecting an upward trend for IPOs?

Broadly, evidence from the 1980s and early 1990s shows IPOs as poor investments on average. However, more recently, this no longer appears to be the case. At this point, IPOs perform about as well as their more seasoned industry peers that are already publicly traded. There are two issues to note, however. First, IPOs perform better when the underwriters backing the transaction are more prestigious. Second, they perform better when insiders are selling fewer of their own shares in the IPO (i.e., when most or all of the IPO proceeds are used to fund new investments and not insider sell-outs). A key challenge for investors is the worry that the manager of the IPO firm is choosing to sell when the market places a high value on stock in its given industry.

How will going public change Facebook?

Facebook will dramatically change its access to capital markets, and in other ways, its public perception. Publicly traded firms can issue equity to fund new investment or to fund acquisitions. It also can use its own stock as a way to buy other firms that it may wish to merge with. These issues increase its flexibility and allow it to be more agile in its market. For example, if Facebook sees the need to merge with another large firm like Yahoo 1-2 years from now in order to stay competitive, a stock swap merger permits the transaction to go through without having to raise a substantial amount of cash, which would be prohibitive for a private firm. On perception, you will have many institutional and retail investors reading its financials and making investments. This will increase the publicity received by the firm and perhaps also public confidence in the strength of its business model. In turn, this may help to secure its market share.

For more information on the Facebook IPO, contact Hoberg at 301-405-9685, 301-405-9685 (mobile) or ghoberg@rhsmith.umd.edu. His personal website is www.rhsmith.umd.edu/faculty/ghoberg

About the University of Maryland's Robert H. Smith School of Business 

The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and part-time MBA, executive MBA, online MBA, MS in business, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.