Facebook reveals what makes its network tick

The first close look that Facebook gave the world of its finances spoke volumes about what makes the social networking company tick.

Mark Zuckerberg, though still only 27, is firmly in control of the consumer internet phenomenon, controlling nearly 57 per cent of the company’s voting stock – nearly as much as the combined voting that Google co-founders Sergey Brin and Larry Page wield over their company.

To judge from the idealistic tone of the founder’s letter included in the registration papers filed with the Securities and Exchange Commission on Wednesday, he sees Facebook’s long-term potential as much in social as in business terms.

“Facebook was not originally created to be a company,” Mr Zuckerberg said. “It was built to accomplish a social mission – to make the world more open and connected.”

In spite of such strong echoes of Google’s 2004 IPO filing, Facebook has shown itself far more willing to play by the rules of Wall Street. Mr Zuckerberg made no repeat of the Google founders’ warning to investors that theirs was a “different kind of company”, one that would not pay attention to the usual concerns of the financial markets, such as short-term profits – a stance that contributed to perceptions of arrogance that alienated many potential Google investors.

Moreover, while the search giant thumbed its nose at the traditional Wall Street power structure by selling its shares through an auction, some of the best-known investment banks will be firmly in control when Facebook makes its stock market debut, probably in May.

Morgan Stanley won the lead bank position for the deal, as anticipated – a position it also held officially in the Google IPO, even though the role of the banks was severely reduced in that deal. Notably, Goldman Sachs was dropped into the third position, with JPMorgan taking second spot.

People close to the deal said that Jimmy Lee, a senior banker at JPMorgan, had been heavily involved in the discussions. Bank of America Merrill Lynch, Barclay’s Capital, and Allen & Company won supporting roles.

As expected, Facebook’s filing showed that it will have a dual-class share structure which will keep most of the voting power in the hands of early investors, echoing the practice of most of the internet companies that have recently come to Wall Street. However, Mr Zuckerberg’s continuing sway over the company will owe as much to his allies as to his personal stake.

A number of other early investors, including co-founder Dustin Moskovitz and early employees Sean Parker and Matt Cohler, have given Mr Zuckerberg the power to wield their shares under long-term agreements. Those deals account for more than half of the personal voting stake that Facebook’s chief executive will retain, according to the filing.

In terms of the progress of its business, Facebook’s figures suggest that its advertising base has yet to develop as far as many of its supporters had hoped – though it has already achieved strong profitability.

At $3.71bn last year, its revenues were below the $4bn-$4.5bn range anticipated by most analysts. Nevertheless, it represented growth of 88 per cent from a year before, with advertising income growing at a slower 69 per cent and higher growth from the payments and other revenues that now account for 15 per cent of revenues.

The Facebook phenomenon has had a sweeping effect on the advertising business, even if the company itself has yet to generate the sort of returns that many had hoped. According to internet measurement company ComScore, 28 per cent of online display ads served up in the US last year were on Facebook, a jump from the 21 per cent the year before. Yet the company’s share of online display ad spending only amounted to 16.3 per cent, according to an estimate by eMarketer.

“These ads are extremely inexpensive and are bought on an auction basis without any hand-holding [by Facebook employees],” said Debra Williamson, principal analyst at eMarketer.

That flood of advertising inventory has had a wider impact on the advertising market, depressing the prices that other internet companies have been able to charge.

While Ms Williamson described self-service as “a good basic business”, she said: “Where the real dollars are is in brand marketing.”

Facebook is still in the early stages of turning its huge audience into a paying proposition. Based on the figures disclosed on Wednesday, it generated about $5.10 in revenue from each of its active monthly users last year, based on an average of 725m throughout the year. By comparison, Google generated more than $27 in net revenues for each of the more than 1bn active users across all of its services last year, a mark of the power of its search advertising business.

The Facebook number is in line with other recent internet IPOs. Social games company Zynga is estimated to have produced $5 in revenue for each of its 227m active users last year, while LinkedIn, the professional social network, earned nearly $6 for each of its 88m unique monthly visitors.

Meanwhile, with Facebook’s shares trading on the private secondary market at a total worth of about $80bn, the filing added to a growing expectation that it might not reach the $100bn valuation that some investors had hoped would be achieved at the time of an IPO.

Its initial disclosure that it would seek to raise $5bn – though that figure could be raised substantially during the marketing process for shares – was seen as a sign that Facebook is well aware of the risks posed by the overheated build up to its filing.

“Justifying a $10bn offering would have put enormous pressure on Facebook,” said Jeff Sica, chief investment officer of Sica Capital Management, which owns Facebook shares. “There’s still going to be plenty of pressure but this reduced number will put a lid on expectations.”

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