Could Facebook sustain $100B valuation?

Building revenue could be a challenge for social network

SAN FRANCISCO — Is speculation that Facebook could be worth a stratospheric $100 billion when it goes public grounded in reality?

The social-networking giant is poised to file for an initial public offering as early as this week. The IPO could raise $10 billion and make Facebook, on paper, as valuable as Mcdonald’s, with a market value of $100 billion. That would rank Facebook 26th on the S&P 500.

Yet sustaining that high a market cap could be dicey, say IPO and advertising experts. Facebook’s true challenge is in ramping up revenue while competing head-on with Google and others and adding revenue streams beyond its bread-and-butter advertising business.

Facebook needs to jack up annual revenue over the next decade, generating 29% year-over-year growth through 2021, says Anant Sundaram, an expert on corporate valuation and finance professor at the Tuck School of Business at Dartmouth College.

Facebook rang up about $4.3 billion in revenue last year, according to emarketer estimates.

At the same time, Facebook must maintain 30% in operating margin, a number close to the average that Google hit over the past decade. Privately held Facebook does not disclose its margin but will in its S-1 filing to go public.

The immediate concern is for Facebook to crank up ad sales. Facebook gleaned 89% of its annual revenue last year, or about $3.8 billion, from advertising.

Google, with an estimated market value of $185 billion, had $37.9 billion in revenue last year — 96% of that from advertising. Paid search, the heart of Google’s ad business, is considered a more powerful ad tool than a social-networking platform, such as Facebook’s, where people go to socialize.

“Investors have to be comfortable that Google and Facebook would account for a quarter of (an estimated $700 billion) global market for ad spending” in 2021, Sundaram says.

Facebook’s expected valuation of as much as $100 billion, or about “20 times revenue, is high,” says Kathleen Smith, principal at Renaissance Capital. “You have to believe that revenue growth is 50% to 100% over the next couple years to justify that.” Facebook’s revenue growth will need to show that the company can apply social networking to business models beyond ads. It needs “to build a brand new business concept,” Smith says. “Ecommerce, could it be social gaming, music?”