5 Sobering Thoughts About the Facebook IPO

A potential $100 billion valuation could be problematic

   

Facebook Logo 200x100 5 Sobering Thoughts About the Facebook IPO What we do know is that Facebook is expected to come public May 18. What’s a little tougher to tell is whether buying in would be a smart move. Keep in mind that the price range hasn’t even been set yet (though we should know within a few days).

But based on the buzz, the company will be valued at around $100 billion — roughly Facebook’s valuation when it traded in the secondary markets.

If that number seems large, it should. At $100 billion, Facebook would be worth roughly as much as soda ‘n’ snack giant PepsiCo (NYSE:PEP) — astonishing, especially given the much smaller values of the rest of the social media world.

To get a sense of the investment potential, an investor can make some comparisons with similar companies. Let’s take a look at Facebook against …

… Google

Assuming a valuation of $100 billion, Facebook will trade at 33 times advertising revenues. Google (NASDAQ:GOOG) currently trades at 5.5 times that.

There are good reasons for the wide gap. After all, Facebook has a massive audience of more than 900 million monthly active users (MAUs). The company also has troves of valuable information about its base, such as their interests, ages, friends and so on.

But with such a great platform and that many users, shouldn’t Facebook be pulling in much more than $4 billion in total revenues? Consider that Google rakes in roughly $37 billion, even though it has a smaller base of users and far less information about them. At least right now, Google appears to be much better at monetization.

In Mark Zuckerberg’s letter to shareholders, he said: “Simply put: We don’t build services to make money; we make money to build better services.”

Investors expect that Facebook will start focusing on monetization and that the company will grow into its huge valuation. Well, investors: Zuckerberg is saying something very different.

… Apple

The late Steve Jobs was maniacal about building insanely great products and creating a premium brand. He also realized that profits were a necessary part of the cycle, as they would allow for even better products and a more dominant brand.

Apple (NASDAQ:AAPL) actually had a stronger first quarter than Facebook. Earnings nearly doubled to $11.6 billion and sales surged by 60% to $39.2 billion, while Facebook’s earnings fell 12% to $233 million on a 45% increase in sales.

Apple, valued around $550 billion, currently trades around 3.8 times sales. If you applied that metric to Facebook, its valuation would be just $15 billion.

For the record, Facebook blamed its results on seasonality.

Apple didn’t have to explain anything.

… Other Social IPOs

Social IPOs have had a tough run. Take a look at the following chart (which assumes you bought the shares at the close of the first day of trading):

Company Ticker Return
Groupon GRPN -58%
Pandora P -50%
Angie’s List ANGI -17%
Zynga ZNGA -11%
Yelp YELP -8%
Zillow Z -3%
LinkedIn LNKD +13%

Why the bad performances? One key reason is that there was lots of hype during the first couple days of the IPO. But once things subsided, so did the stock prices.

But another thing is that several of these companies — like Pandora (NYSE:P), Groupon (NASDAQ:GRPN) and Zynga (NASDAQ:ZNGA) — have posted disappointing earnings reports. Fundamentals do matter with investors.

The biggest problem Facebook might share is the hype, which could help drive up its valuation past what its future performance might be able to support, and also could lead to a letdown slump after the IPO.

… Pandora

It might not seem like there’s much to compare here. Pandora is a fairly small company when compared to Facebook. But there’s something worth noting: mobile.

Both companies are seeing huge growth in this category. And, of course, Facebook recently plunked down $1 billion for Instagram to further fuel the fire.

The problem is that the mobile business is in the nascent stages of development, and monetizing it has been difficult — a prime suspect in Pandora’s disappointing earnings report.

Facebook likely will do better with its mobile efforts, but it’s still going to take time. And again, while Zuckerberg has a zen approach to monetization — hey, Instagram has $0 in revenues — investors aren’t usually known for their patience.

… The $100+ Billion Mark

If Facebook goes public at a $100 billion valuation, it will be a rare achievement. Consider that the market value of Google at its IPO was only $27 billion (and the company’s revenues were $2.3 billion at the time), though the company did manage to reach $100 billion in about a year.

But since then, Google’s market cap has been in a range of $125 billion to $200 billion or so. And that’s not unusual. Other $100 billion-plus companies, such as Intel (NASDAQ:INTC) and Cisco (NASDAQ:CSCO), also have traded in ranges. They essentially peaked at the $100 billion-plus threshold, and as a result, provided meager long-term returns.

If Facebook is to achieve the same kind of return as Google did after its IPO, it will need to reach a market cap of more than $300 billion — which is getting into Apple territory. Facebook might be starting publicly traded life right against the wall.

Takeaway

In a way, it can be misleading to make comparisons with Facebook. The company is in a league of its own when it comes to Internet properties — in terms of its scale and data on users. No other site even comes close.

Even though Facebook is seeing a slowdown in growth, the company still is generating substantial revenues and profits. Besides, as mobile starts to become more familiar with advertisers, this business should be a big driver for growth, too.

It seems like a good bet that Facebook will have a strong debut, and it might even hold its value. But kicking off with such an enormous valuation ultimately could cause problems with investors, who again are already assuming Facebook will find ways to monetize its platform. So unless Zuckerberg comes up with some new business models and approaches, Facebook’s expected valuation could be ceiling on the stock.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/ipo-playbook/5-sobering-thoughts-about-the-facebook-ipo/.

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