If Facebook Doesn’t Go Public, What Then?

As 2010 gets underway, tech watchers are waiting with baited breath for Facebook to file its S-1, a move that would invariably swing open the IPO gates to a number of other social networking startups that have millions of users and envy-inducing revenue numbers.

But what if a Facebook IPO isn’t as imminent as everyone anticipates? Yes, it introduced a dual-class structure in November — just as Google did before going public — but Mark Zuckerberg doesn’t make decisions on anyone’s timeline but his own, seemingly. If the company decides to wait, will LinkedIn and Zynga executives be left looking at their timepieces and tapping their shoes?

Earlier today I explored the question with Terry Schallich, managing director and head of equity capital markets at the tech-focused investment bank Pacific Crest Securities:

Obviously, it’s expected that a number of strong social networking sites, including Facebook, LinkedIn, and Zynga, could and may go public this year. I’m wondering: does Facebook need to go first?

I don’t think so. Facebook, LinkedIn and Zynga are all great companies with the financial scale and maturity to be public companies. I don’t think that any of them needs to go public, nor that there’s any particular importance that hinges on the order in which they come public. When their executive teams and their boards want to make a move to address the public markets, they should be completely successful IPOs.

Zynga’s CEO has suggested that he’d rather wait to IPO; Facebook typically dances around the IPO question. Do these companies need to strike while the iron is hot?  

There’s a risk in every business model that you’ll offend your constituents or that something else will occur that negatively impacts growth, whether interactive media, software, or consumer devices. There’s always a risk that revenue growth will slow. Around social media, given the rise and fall of Friendster, for example, people will point to a nightclub analog, but with these three companies in particular, I don’t think that fear of slowing growth will be a motivator to move forward with an IPO. We’re not seeing any evidence of a curtailing of user growth; on the contrary, every time you look, it seems that Facebook has managed to register another 50 million people. Further, while already material in amount, [these companies] are all at the front end of generating revenue. At the end of the day, these are properties that institutional investors would love to have.

How many tech companies do you estimate might go public in the first half of this year?

Beyond the 25 information technology companies that are in registration, we’re tracking another 20-plus companies that have bankers and that have had organizational meetings but haven’t yet filed.

How alike, or not, are these companies’ profiles in terms of sector and revenue? 

We’re seeing companies across the technology spectrum, from communications hardware to software and Internet, move toward public offerings. These are companies that have mature P&Ls and are growing at very good rates. These are not bubble-type companies. They aren’t being valued off eyeballs or other nonfinancial metrics.

Do they mostly have annual run rates of roughly $100 million or more? That seemed to be the bar before the recession struck. 

The companies that we’re following in the channel aren’t all at that revenue run rate but are very strong companies. That [$100 million] run rate is a bit of a convenience and an artificial threshold. Different subsectors within tech trade at different multiples. Institutional investors are more focused on opportunities to achieve meaningful gain and on companies that have big enough market caps that they can move in and out of their positions without impacting the performance of the companies’ stock.

And what size market caps allow them to do that safely? 

The average market cap of the 18 tech IPOs that priced in 2009 was about $565 million. What we typically look at is: does the company’s P&L and expected growth and relevant multiples support a market cap of $300 million or higher? I can assure you that Facebook, LinkedIn, and Zynga wouldn’t test that threshold. 

Your clients are institutional investors. Do you sense that they want to see more from new issuers than in the past? Tech didn’t tank the economy, but I’m wondering if they’re more skittish anyway.

As executives sit in front of buyside analysts and portfolio managers, they are probably having to have slightly longer conversation around the reliability and durability of their forward-looking revenue, and to demonstrate that with past performance. But that’s not materially different than that of past IPO windows. The tech sector has always been cyclical. It consistently runs a four- or five-year cycle, and on the front end of that cycle, management teams need to be prepared to spend more time convincing institutional investors that there’s great prospect for growth and that they can minimize risk associated with execution.

And are they more excited about particular sectors right now?

We are seeing institutional investors looking for recession-recovery plays that can capture the upside of a broader economic recovering. Online advertising is one example. As we see companies that have historically had large ad budgets come back into the market, spending more of their money on advertising, and increasingly share shifting to online advertising as that’s the medium where most of the audience is aggregating, investors will play off that recovery in spend.

You’re seeing a little bit of that in online travel, too. If you look at the stock performance of Expedia, Priceline and Orbitz over the last four to six months, their multiples have expanded in part as a result of the overall recovering in travel.