Can Facebook Live Up to Its Valuation Hype?

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Earlier this month, Facebook filed documents with the U.S. Securities and Exchange Commission setting in motion an initial public offering that has investors clamoring for a piece of the Internet giant and dreaming in dollar signs.

In its filing, the company indicated that it would seek to raise $5 billion through the sale of stock, although analysts predict that number could be as high as $10 billion. It would be the largest Internet company stock sale since Google ( GOOG) went public in 2004. Analysts put the value of the company between $75 billion and $100 billion, depending on investor appetite.

At the same time, Facebook revealed a set of solid financials that has potential investors taking notice. The company recorded $1 billion in profits last year -- its third straight year of profitability -- from $3.71 billion in revenue.

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By comparison, Facebook far outpaces Internet rivals that have recently made the transition from private to public entity. For example, when Facebook game developer, Zynga ( ZNGA), went public last year, it posted a comparatively tepid $90.6 million in profits, while LinkedIn ( LNKD) was barely profitable and Pandora ( P) was still in the red.

Certainly no one can gainsay the success that Facebook has had in the eight years since its founding. Its user base has grown exponentially -- 845 million and counting, albeit a generous counting -- making it by far the world's largest social network. And with a string of profitable years under its belt, it appears to be poised for success. Among those sure to benefit are the Wall Street banks, including JPMorgan Chase, Morgan Stanley, Goldman Sachs and several others that will generate tremendous fees through the process.

But, just as with the companies that have gone before, Facebook must answer some tough questions about how it will build value for shareholders, not just generate wealth for bankers and insiders. Facebook must show that it can continue to successfully navigate the transition from a freewheeling, innovative Internet start-up hatched in a Harvard dorm room to a disciplined and structured public company that must, first and foremost, meet the demands of the market and its investors. And to do so, it must develop a skill-set that may be perceived as antithetical to the very skills that made it a success in the first place.

Will Facebook produce sufficient revenues and earnings to justify its implied enterprise value?

It is by no means a sure bet. Consider two examples. According to Bloomberg data, shares of Groupon ( GRPN), the once meteorically expansive Internet coupon company, gained some 31% in its first day of trading, but ended the month of January down 22% and reported an earnings loss of $37 million.

Just this week, Zynga shares plummeted 11% , the largest drop since its shares started trading last December, while earnings fell by 34%. The company blamed higher-than-expected product development costs, but analysts noted that expectations on the Street were simply too high to sustain, with " too much optimism built into the stock price."

In each of these cases, company valuation pre-IPO was in the tens of billions, which, in hindsight, perhaps reflected the popularity of their technologies rather than any proven ability to turn a profit.

Published reports indicate that Mark Zuckerberg himself harbors some concerns about how heightened scrutiny and profit pressures will change his company. In the same reports, he has been quoted as saying that he will maintain focus on product development rather than maximizing profit. Whether that will be a successful strategy remains to be seen.

By all accounts, Zuckerberg has assembled a top-notch management team drawn from more mature Internet companies. They may provide the gravitas and experience Facebook needs to succeed. Indeed, to achieve the kind of share price and valuation it hopes to command, Facebook would do well to heed the lessons of other companies that successfully transitioned into the public sphere by ensuring effective two-way communications with investors.

The fundamental lesson is to clearly communicate a business strategy for building shareholder value, including metrics and benchmarks that provide analyst and investors with the ability to track the company's progress. It means setting reasonable expectations among financial community professionals, and then meeting those expectations though careful management of the balance sheet.

It also means fully engaging investors to gain a realistic understanding of what they actually think about your company and its strategy. That is priceless information for companies in their efforts to adjust their actions and refine their messages for all stakeholders.

Follow Richard Levick on Twitter@richardlevick.Richard S. Levick, Esq., is the president and chief executive officer of Levick Strategic Communications, a crisis and public affairs communications firm. Levick is on the prestigious list of "The 100 Most Influential People in the Boardroom." He is co-author of The Communicators: Leadership in the Age of Crisis and Stop the Presses: The Crisis & Litigation PR Desk Reference, and writes for Bulletproofblog. Reach him at rlevick@levick.com.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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