Wednesday, February 1, 2012

Running Like Hell From The Facebook IPO.

Sooooooooo. I just went through the Facebook S-1 to take a look at what it said about second most popular site on the internet. While I had figured that the company would fetch some lofty valuation, I thought "well, I shouldn't judge them before I actually look at the numbers..."

After reading through the filing, I thought "Anybody that would value this company at $75-$100 BILLION dollars is either stupid or delusional to the point of historically needing to have been put on trial." Ok, so, that might seem a bit excessive. But, lets take a look at it before anyone says anything too rash.

Let me be clear, I have no idea as to how to accurately predict the growth of the company hence, I am going to take it to the almost illogical extreme for this thought exercise. Presently, it seems that their ad revenue growth is slowing considerably. In 2009, ad revenue was $764 million. In 2010, it's revenues from ads were up an impressive 145%, or, up to $1.686 billion. Then, in 2011, growth started to slow... to 69% providing us with a total of $3.154 billion in ads sold. While there will certainly be a long term shift from advertising in print to the internet, Facebook doesn't have a monopoly on ads. I highly doubt that they will ever have anything close to that. After all, Google had over $36.5 billion in advertising revenues last year... more than 10x the amount of Facebook.

Facebook presently boasts 845 million active monthly users, which equates to $3.72 dollars in yearly ad revenue per monthly active user (based on a 2011 total of $3.154 billion in ads).

So, lets say that everybody in the world magically had a computer with internet access- presently, 6.8405 billion people. Now, lets also assume that they all develop the same usage as our present average monthly Facebook user and that companies were willing to pay Facebook the exact same amount for advertising as they presently do per user... Facebook would then generate $25.4466 billion in ad revenue (don't get me wrong, is impressive, but, still not up to Google standards). If the company can keep the same margins of earnings related to the revenue (presently, ~21.2%: based on $3.154 billion in ads, which is slightly less than their total revenues, and $668 million in earnings for the A and B shares) then you are looking at a company that would earn just under $5.18 billion dollars a year.

Now, in what I don't think is a stretch to call an "overly rosy scenario" if the company is at that point valued at $75 billion, the stock would have a P/E ratio of ~14.5. If the company is valued at $100 billion, then the P/E ratio would become ~19.3. At that point, there would be very few ways for Facebook to justify a P/E that was at that level, unless you thought that they could juice margins, people will start spending a whole lot more time on Facebook (even though on page 3 of the prospectus, the company boasts that users upload 250 million pictures to the site PER DAY), we find an alien life form that would want to use the site, advertisers pony up more money for advertising on the site, or a few other various reasons. Maybe it get's infinitely cheaper for Facebook to add users in the future? But, due to how marginal cost works, I don't think that will last forever... Besides, their margins are already about as hefty as Googles!

Regardless, anyone buying the stock had better have some really good insights as to how the company can grow, because if the news stories are right in regard to it's coming market price, it will be trading between 112x and 150x 2011 earnings. In the meantime, I will stick to stuff that I have a very high degree of certainty is cheap and pass up any chance that I get to buy shares of Facebook on the open market. When comparing Facebook to Google, it almost seems like a bet on Facebook is not only a bet for Facebook, but, also a bet against Google; remember, Google has over 10x the ad revenue of Facebook, nearly 11.5x the cash on hand, and is nearly 15x as profitable, with a market cap that is ~2x what Facebook's is expected to be.

The bottom line seems to be this, Facebook is going to need to figure out alternative ways to make money; ads just won't cut it to justify the stock price that that has been predicted.

Good luck to all of you buying shares in the IPO.

Disclosure/Disclaimer: I have no financial position or interest in or against, in any regard, to any of the entities mentioned. This is not advice of any kind. Always do a ton of your own research before contemplating doing anything that I say, do, write, or so much as think about.


Anonymous said...

One interesting article..

jeff said...

It looks like that guy had the same thinking as I do, but wrote about it last June. Good find.

Anonymous said...

what do you think about potentially shorting it?

Ankit Gupta said...

Something else to think about is that I believe Google earns something like $25/user whereas Facebook is in the $5/user range and so there's still a *ton* of room for Facebook's advertising to ramp potentially ramp up in the amounts being charged.

I think the best way to dig into this is to look at what kind of results businesses are seeing to determine if this is because a lack of business maturity or rather something inherent about Facebook, which will remain.

Anonymous said...

This reminds of 2004, when Google was coming public. It felt like the bears outnumbered the bulls by a factor of 20:1. There were endless articles bashing the IPO valuation, most with the same core premise of, "Do you realize that Google needs to grow revenue by X% per year for the next five years to justify this valuation? That's NEVER happened before!" Then the internet blew up even more, Google not surprisingly found a giant new revenue source (AdWords), and the stock was a 7 bagger over the next 36 months.

The Facebook bears are making the exact same stupid mistakes they made eight years ago with Google.

jeff said...

Personally, I am not going to short it for the reasons that you cite. I said in the write up that they would need to find new sources of revenue, but that they were still an unknown. I personally like betting on things that I am pretty sure about- frankly, I have no way of knowing how Facebook will monetize things, or when they will do so.