$188 $(56) 2011 $606 Cash & Equivalents Free Cash Flow $153 $1,000 Revenue 2010 $1,974 $(138) 2009 $66 $777 2008 $3,711 $3,908 $297 $(55) 2007 $(88) $470 Unless you’ve been living under a rock (or on MySpace) for the last two weeks, you’ve most likely heard that social networking giant Facebook filed for its IPO. The form S-1 contains a plethora of information “the Street” had been mulling over for months. Most important was the company’s 2011 net income, which was up 65% annually to $1 billion. Although the company had a net income loss for 2007 and 2008, its earnings growth since has been astounding. Since 2009, the company has averaged annual net income growth of 115%, while revenue has increased on average 80% over the same period. $272 $1,785 $229 $633 $305 Net Income The company has been amassing a treasure chest of cash. With nearly $4 billion at the end of 2011, Facebook can cover operating expenses for two years without any additional revenue, granting investors a wide margin of safety. Free cash flow has consistently grown since 2008, with an average annualized growth of 103%. In addition to the income numbers, the public was able to peek inside Facebook’s user base for the first time. According to the form S-1, the company had 845 million monthly active users (MAUs) and 483 million daily active users (DAUs) at the end of 2011, up 39% and 48%, respectively.(Click on image to enlarge)However, as Andrew Sorkin points out, Facebook is very, should we say, generous when calculating its user base. The main point of contention is that Facebook counts users as “active” even if they didn’t actually visit Facebook.com, which skews the company’s reach and thus the amount advertisers would be willing to pay for ad space.To Facebook, a user is considered “active” if he or she “took an action to share content or activity with his or her Facebook friends or connections via a third-party Web site that is integrated with Facebook.”For example, if you clicked the “Like” button on a New York Times article, shared music on Spotify, or signed into the Wall Street Journal using your Facebook account and left a comment that was subsequently shared on Facebook, you’re counted as an active user, even though none of these actions actually took place on Facebook.com. The catch is that advertisers won’t have an opportunity to market products to these “active” users.Even though Facebook seems to have massaged its active users stats, Nielson estimates that Facebook had roughly 153 million MAUs in December, which is only 8 million off the prospectus estimate of 161 million MAUs. So, the company does have a healthy advertising base and appears to be fundamentally strong. Even so, there are other risks that the company will need to overcome in order to continue its success.Growth(Click on image to enlarge)As the graph above illustrates, growth in key markets such as North America and Europe is already tapering off. Sources claim the US market could already have a saturation rate of 75%. From the form S-1: “We believe that our rates of user and revenue growth will decline over time. For example, our annual revenue grew 154% from 2009 to 2010 and 88% from 2010 to 2011. Historically, our user growth has been a primary driver of growth in our revenue. Our user growth and revenue growth rates will inevitably slow as we achieve higher market penetration rates, as our revenue increases to higher levels, and as we experience increased competition.”Once Facebook’s user base inevitably plateaus, their performance will become increasingly dependent on their ability to increase levels of user engagement, which entails generating new, useful products. However, Facebook still has opportunities for user growth in emerging markets, such as Asia, Africa, Latin America, and the Middle East.AdvertisingFor 2009, 2010, and 2011, advertising accounted for 98%, 95%, and 85%, respectively, of Facebook’s revenue.Working in their favor is Facebook’s vast knowledge of their users, which could allow the company to deliver ever-increasingly targeted ads. If they can increase the relevance of their ads, they’ll be able to increase their advertising base, along with the price they charge per click, thus providing an opportunity to raise revenues.One caveat to this opportunity is that Facebook is at the forefront of complex and evolving US and foreign laws and regulations regarding privacy and data protection, which could result in regulatory action in coming years. This could entail future restrictions on the data Facebook can gather and use to deliver targeted ads. MobileCurrently, Facebook’s mobile app does not carry advertisements. With more and more users accessing Facebook through mobile devices, the company will need to reevaluate its mobile strategy.Without any leverage in the mobile marketplace, an opportunity is created for Google to push its Google+ social network on Android devices, along with Apple’s recent affinity for Twitter on the iOS. Without a native mobile operating system, Facebook is at a clear disadvantage.However, Google+ has had difficulty gaining traction and currently has “only” 90 million users, while Facebook is still considered a mainstay in the social networking industry.Key-Man RiskLast but certainly not least, the company’s chairman and CEO Mark Zuckerberg poses a significant key-man risk for the company. Zuckerberg (who was mentioned 113 times in the S-1 filing) owns a large majority of the company’s voting stock and thus has control over key decisions. Placing this much emphasis on one person (regardless of how brilliant) is rarely a good idea.On the flip side, Zuckerberg’s track record proves he can lead a growing, profitable company. But the question is whether he’ll be able to keep it up.