Why Facebook's IPO could be disappointingly weak

Facebook is expected to go public this year, and sources in Silicon Valley say the fast-growing social-networking company is anticipating a blockbuster. But could such speculation be premature?

Indeed it could. A few days ago, word surfaced that Facebook's semi-stealth share buyback was oversubscribed. Demand was so high that former employees got pushed out of the buyback pool, with preferential treatment going those currently working there. The upshot: the people with the best insight into Facebook's valuation voted on what it's truly worth. And those people were heading for the exits.
Employees taking part in the buyback could sell stock equal to the lesser of 25 percent of their holdings or $1 million, according to TechCrunch, which broke the news and which said that the deal valued the company at $6.5 billion.

If Facebook were a public company, this would be a very bad sign indeed. It would be the equivalent of high-speed insider selling and legions of employees betting that the company in fact is worth less than $6.5 billion.

The buyback totaled $100 million and was executed by Digital Sky Technologies, a Russian Internet holding company and investment group. In May 2009, Digital Sky also funded a $200 million private placement in Facebook. The size of the buyback was relatively small, given that Facebook is probably worth at least several billion.

Pegging a valuation to Facebook is a favorite venture capitalist sport. Legal documents resulting from a lawsuit against Facebook founder and CEO Mark Zuckerberg implied the company was valued at $3.7 billion, the New York Times reported in July 2008. TechCrunch asserted that Facebook turned down termsheets valuing the company at $8 billion in May. Microsoft (MSFT) invested $240 million in Facebook at a nosebleed valuation of $15 billion back in 2007. Various media accounts have pegged Facebook's valuation, according to potential investors, at between $2 billion and $4 billion. The company's shares have been selling on the secondary markets for some time now, as reported by the Wall Street Journal, but not with enough liquidity to nail clear valuations.

One thing appears certain now. The IPO that is likely coming later this year will struggle to hit the $6.5 billion valuation market and may come in well below $5 billion. Social networking is still proving hard to monetize, it appears, as the Twitter guys are learning the hard way -- and as Facebook employees have already confirmed.
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