I have several friends who think the Facebook IPO is the next Microsoft (NASDAQ:MSFT). I think it’s more likely the next Research in Motion (NASDAQ:RIMM) — or perhaps the next Sony (NYSE:SNE), Kodak (PINK:EKDKQ) or China Eastern Airlines (NYSE:CEA) — all of which were once world-class brands that got muscled aside by brash new competitors.
With Facebook, you may as well buy a lottery ticket.
Don’t get me wrong — in just a few short years, Facebook has accumulated an unprecedented 845 million users representing 12.07% of the world’s population. But does that merit an offering worth as much as $100 billion? Maybe to a lot of people, but not to me. Let’s look at the numbers:
There are now 7 billion people on the planet — 5.15 billion of whom live on $10 or less a day. Of that 5.15 billion, roughly 3 billion live on less than $2.50 a day. That means if you remove those who live on less than $10 a day — because it’s reasonable to assume they can’t afford a computer or have enough disposable income to be monetized — that leaves roughly 1.85 billion potential Facebook users.
In a perfect world, where a company could capture 100% of its target market, that would cap Facebook’s potential user growth at 118.93%. But we don’t live in perfect world. As far as I know, no company has ever captured 100% of its target market — not once. There are always those who drop off, leave or simply don’t buy no matter what the product is or how good the offer.
That’s not to say a 100% share couldn’t happen, but unless Team Zuckerberg figures out new ways to monetize users or invents an entirely new class of customer, there is relatively little upside remaining in terms of the company’s target market.
Facebook’s Fuzzy Math
According to Yahoo! (NASDAQ:YHOO) Finance, Microsoft‘s (NASDAQ:MSFT) adjusted close on March 13, 1986, was 8 cents. As of January 30, 2012, the stock was trading at $29.61, which means Microsoft stock has delivered a mouthwatering 36,913% return over the last 26 years. For Facebook to deliver similar returns at its proposed $100 billion valuation, Facebook’s market cap would have to soar to $36.21 trillion. That’s roughly 57.47% of the entire world’s GDP.
Possible? Sure. But there’s a big difference between possible and probable.
If Facebook is really worth $100 billion, that means the company would come out of the gate at roughly 27 times 2011 sales and nearly 100 times 2011 earnings. By comparison, Google (NASDAQ:GOOG) trades at 5.22 times sales and carries a P-E ratio of 20.42 times earnings. In other words, you’d have to wait 100 years to justify your Facebook investment, versus a mere 20.42 years for Google. Dividends would obviously bring that figure down in a hurry, but to my knowledge the company has no plans to issue any.
Google went public in 2004, raising $1.9 billion against a valuation of $23 billion — a record as the largest U.S. Internet IPO, which has stood until now. At the time, that worked out to 10 times sales, or less than half of Facebook’s proposed initial valuation. Even Apple (NASDAQ:AAPL) — by a far more dynamic company, backed by real products — trades at only 3.38 times sales. That’s less than 20% of the estimates for Facebook’s projected price-to-sales ratio. And Apple has a market cap of $460 billion.
At the end of the day, I realize that nothing I say can change your mind if you’ve decided to take the plunge, so I’ll wrap up with one final thought.
Investors who fancy tech stocks often argue that the future matters more than current valuations, no matter how absurd they might be. That’s why stocks like Facebook are “worth” the risk. I have no comeback for that. I can’t foresee with how a technology might be used 10 years from now. But I can point out that companies such as Apple, Google, and Microsoft are fairly valued based on current earnings, cash flow and their respective cash stockpiles. In other words, their stock prices reflect stuff that could realistically have a material effect on how each of these companies grows within the next 12 months — or not.
So where does that leave us?
If you’re a day trader and you have money to burn, Facebook may make a superb opportunity. I think it could easily double on nothing more than the greater-fool theory. For those not familiar with the greater-fool theory, that’s where you plunk your money down on nothing more than a wing and a prayer (because you don’t have earnings, sales or real products to back up your chosen investment) and hope that a greater fool comes along at some point who’s willing to pay you more than you spent to buy the stock. The problem is, you were the greater fool first.
But if you’re an investor, I’d wait a year. Let Facebook go public and bleed out the hype. Give it time to build a public track record. Then, using that data, make a market-based determination as to whether or not you want to invest.
Still not convinced? I have one word for you: MySpace.