That’s my opinion, anyway. I believe the valuation put on the Facebook IPO is asinine. I am of the opinion this is the type of valuation that only a complete, total, idiotic moron who wanted to get screwed could accept. Again, this is entirely my opinion looking at the financials. I’m about to wrap up my work for the night but here is a brief overview of how I see the situation.
Remember what Benjamin Graham said … at what price and on what terms? Let’s look at both.
Why I Think the Facebook IPO Is Overvalued (By the Numbers)
Facebook is a business. It’s actually a fantastic business that generates beautiful returns on equity, has a dominent market position, and enjoys strong user loyalty for the time being. The existing owners want to sell out some of their ownership stake and raise a little money. They plan on selling 337.4 million shares, raising $11.8 billion in cash. That would put the valuation of the entire business at $96 billion.
What are investors getting for $96 billion?
- An online social platform that generates roughly 83% of its money from advertising. The rest mostly comes from Facebook payment credits for games, etc..
- Sales of $3.71 billion
- Net income of $1 billion
- Current customers total 900 million users, of which 526 million are active, daily users.
Remember the lesson I’ve taught you countless times? When you invest your money, your job is to buy the most profit you can. It doesn’t matter if $1 in profit comes from advertising, as in the case of Facebook, or from selling roasted coffee beans in a little cart at the county fair. It doesn’t matter if the dollar comes from an “exciting” business, like a Hollywood movie studio, or a “boring” business like a water treatment plant. A dollar spends the same regardless of how it was generated.
That means our base valuation for the Facebook IPO is 96x earnings. That works out to an earnings yield of 1.04%. If the company were to pay all of its profit out as dividends, you would get hit with a 15% dividend tax, so adjusting for that, your net earnings yield is 0.88%. That is 88 basis points. That is 88/100 of 1%. That is a rounding error.
What is our opportunity cost? Right now, the 30 year United States Treasury bond yield is 3.07%. That is 307 basis points.
Think of it this way: If Facebook never grew, and remained the same size forever, you would make 300% more profit per year by buying and holding long-term Treasury bonds until maturity, which are guaranteed by the taxing power of the United States. You’d take less risk, and get paid 3x more. This is basic earnings yield vs. Treasury bond yield stuff you should know as a freshman finance student and it fails even that test.
The Entire Justification for the Overvalued Facebook IPO Is Future Growth
Thus, we know that the underwriters – the people trying to unload the stock on the public – are implicitly arguing that Facebook’s growth will be huge following the IPO. Okay, let’s look at that. I normally get nervous when people insist on having you pay for chickens that have not yet hatched, but we’ll examine Facebook’s track record.
Last year, revenue was up 88% over the previous year. This year, it is expected to be up 64%. Notice a trend? The growth figure is dropping. Plus, remember, they already have 1 out of 7.77 people on the planet as users. To continue growing quickly, they have to introduce new, untested products, get existing users to spend more time on the site, and / or convince the rest of the globe to become obsessed with Facebook.
Then there are the low switching costs. I shut my Facebook account down back in February and haven’t thought about it much since. All of the pageviews, followers, comments, likes, and game credits I generated evaporated overnight. You don’t want to be in a business like that unless you have some diversification. Many of the younger people I know don’t spend time on Facebook, they hang out on Tumblr.
But say we give Facebook the benefit of the doubt. Say that they are wildly, madly successful. They grow profits by 1,000% by getting every man, woman, and child on the planet to obsessively check their Facebook account. Profits would stand at $10 billion. After this perfect scenario, when everything has gone right, rainbows and kittens have bloomed out of flowers in fields of strawberries and Mary Poppins herself is taking the Facebook employees on wellness outings at corporate headquarters, this feat, which presumably would take years to accomplish, would result in an earnings yield of 9.6% on cost. If all the net profit were distributed as dividends, you’d pay the 15% dividend tax, leaving owners a take-home earnings yield of 8.16%.
But even major components in the Dow Jones Industrial Average provide higher returns than that right now. At this very moment. ExxonMobil, for example, has an earnings yield of 10%, and a net earnings yield of 8.5%. It would never even have to grow. It could remain precisely the same size to generate that return year in and year out, assuming stable energy prices.
Looking at the Facebook IPO valuation from another angle, if Facebook performed a miracle on the scale of walking on water, and grew from $1 billion in profit to $26 billion in profit, making it the same size as Apple, due to valuation compression, the best an investor could reasonably hope for would be turning every $1 into $5.56 before taxes due to a market capitalization rise from $96 billion to $533.47 billion, putting it on par with the Cupertino giant. That presumes there are no share issuances for employee compensation, which is unlikely. Could it happen? Sure, anything could happen. That isn’t investing. That is a lottery. There is no rational way you can get to those numbers short of a miracle, and you don’t invest in miracles. Not if you want to get rich in the long-run, anyway.
The Facebook IPO Terms Are Atrocious
Even if you could somehow have intellectual denial sufficient to get past the obscene valuation, there is a bit of a problem in that Mark Zuckerberg has uncontested control of the business with 56.9% of the voting power, despite holding only 28.2% of the stock. That means, for all intents are purposes, you aren’t an equal owner, you are merely along for the ride. It’s like some of the much maligned dual class voting structures you see at other businesses.
Final Thoughts on the Facebook IPO Valuation
What makes the Facebook IPO so interesting is that Facebook is a very good business. Mark Zuckerberg has built a tremendously successful enterprise. In effect, he owns 28.2% economic ownership in a company that churned out $1 billion in after-tax profit last year, giving him $282 million in net income indirectly through his dorm room start-up. That is immensely impressive. It’s huge. It puts him in a club that includes a handful of successful elites like Michael Dell and Bill Gates. He should be enormously proud, studied in business schools, and emulated in careers.
With growth, and current income, I think Mark Zuckerberg is worth no more than $5 billion, rationally valued. For a 27-year-old guy, that is mind boggling. It’s awesome. He will always be in the history books, and rightfully so. The idea that his 28.2% equity stake is worth $25 billion? It’s madness. Utter stupidity. Delusion.
Anyone that buys at these prices is, in my opinion, a fool. Could the stock skyrocket? Of course. The Dutch lost their minds, too, over tulips a few centuries ago and were selling farmland that would produce centuries worth of food for a few, prize bulbs. But bubbles always end. When they do, the last one holding the bag is often ruined for life, or at least severely harmed. I think the banks that are underwriting this deal should be sued into oblivion, and the bankers involved held personally liable. That is how immoral I think the whole thing is. It is preying on the uninformed, the financially gullible, and the easily swayed masses who can’t tell you the difference between LIFO and FIFO.