Coming at this from another direction, let’s assume that cash flow and net income will be the same in the years ahead. Let’s further assume the same growth rates shown above for 2012-2014 and add these rates for subsequent years:
When we apply a 10% discount rate to these data, we come up with a discounted cash flow valuation of $27.
With either approach, Facebook appears to be overvalued based on the ultimate arbiter of value, profitability. But the picture may be even worse than we’ve painted. Every assumption depends on tremendous – yes, slowing, but still on the “billions of dollars per year” scale – growth; and there are red flags popping up all over the place in that regard. Here are a few:
- General Motors, questioning their effectiveness, recently withdrew its display ads on Facebook. (Speaking of General Motors, Facebook’s market cap is bigger than GM’s and Ford’s combined!)
- Revenue from advertising on mobile devices is likely to disappoint; the screens are simply too small and commerce activities less common and for lower value, to be as effective at advertising.
- In his IPO letter, founder Mark Zuckerberg wrote: “We don’t build services to make money; we make money to build services.” In other words, maximizing revenue is not his priority. He is reluctant to extend ads beyond a certain point because he believes they become intrusive and compromise the experience. Noble as this may be, it will hamper the growth needed to justify the stock’s lofty valuation. Of course, Zuckerberg is a billionaire still at $27, $20, even $5 for the stock…
The Winners and Losers
With the company’s stock dropping, retail investors getting the hose, and profit opportunities coming, did any of the stakeholders win in the IPO process?
The primary loser in Facebook’s market debut appears to be the retail investors, because they were sold shares at an inflated price, based on inflated estimates that the investment banks making them knew to be wrong. However, it’s possible that Facebook will turn out to be a profitable investment still; and if it is, my hat’s off to you for taking the leap – we were busy focusing on opportunities with the odds more in our favor.
A close second in the loser category is Nasdaq. The exchange lacked the technology to properly handle the massive order flow, an ironic twist for the de facto “technology exchange,” and the original electronic trading platform that once decried the failures of the NYSE to meet customer demand. As a result, many orders were either delayed or altogether failed to process. Obviously, the botched job could cost the exchange future business.
The primary winner is Mr. Zuckerberg for numerous reasons… 19.1 billion or so little green ones.
His cohorts also did fairly well, too. Here are just a few examples:
Facebook employees made out well on the deal, too… at least the ones there early enough to get sizable grants. We’ll know pretty soon just how many millionaires the event created, we’re sure – but it’s safe to assume quite a few. Let’s just hope for their sakes that the reality of earnings potential doesn’t hit too hard before their lockout periods expire.
In addition, some savvy traders apparently got in near the offering price and jumped ship in the $40s – probably a high-frequency trading firm or two.
The underwriters (e.g., Morgan Stanley) go into the “yet to be determined” category. Sure, they made a mint on the deal, but they also have drawn the attention of the busybodies in Washington, D.C. And any time Washington busts out the red tape, we all lose.
[Sometimes the best investment advice is not to jump on a bandwagon – not only to avoid a drop such as Facebook’s stock continues to experience – but also because that allows the savvy investor to deploy capital where it’s more likely to reap rewards. Facebook’s face-plant is a potent reminder for tech investors: the tech wars are ongoing and may get even bloodier. Don’t let your portfolio be splattered by them.]
