I have been thinking a great deal about what the Facebook IPO means. While reading many posts up at Hacker News about whether we are in a bubble, lamenting Zynga, or skewering Groupon, I am left wondering what will really become of Facebook.
The tl;dr version is that I can’t sign up for Facebook at this price. I have many friends there, and I am happy for them, but I find the valuation a bit too rich to be comfortable investing.
I started off using Bing Finance to use their stock screener to see if I could paint an interesting picture of how Facebook compares to other public companies.
First I started with valuation. Setting a minimum valuation of $74B (which is the low end of the Facebook filing range) yields 95 companies. Notable in that list is my current employer at $101B. Other notables – Anheuser-Busch ($120B), Apple ($532B), ATT ($193B), Chevron ($203B), Cisco ($102B), Comcast ($79B), GE ($204B), Google ($198B), Intel ($139B), IBM ($235B), McDonalds ($97B), Microsoft ($257B), Merck ($117B), Pfizer ($169B) Qualcomm ($106B), The Home Depot ($78B), The Walt Disney Corp($78B), Verizon ($115B), Visa ($96B).
For my second filter, I wanted to add a revenue line. According to their S1, for the year end 2011, Facebook had revenues of $3.7B. I will use that as a min bar. I then set a max revenue range to $10B, which leaves plenty of room for hyper growth in the first year. That reduced the list to just one company. Visa. The company that makes money on just about every payment transaction in the world. Further, with earnings per share of $3.57, they have revenues of $8.5B, and a market cap of $96B, the high end of the Facebook filing range.
If I remove the top end filter on revenue, the list of 95 drops to 40. From my notables list above, the following remain:
Amazon ($48B), Anheuser-Busch ($39B), Apple ($108B), ATT ($114B), Chevron ($244B), Cisco ($43B), Comcast ($56B), GE ($142B), Google ($38B), Intel ($54B), IBM ($107B), McDonalds ($27B), Microsoft ($70B), Merck ($48B), Pfizer ($67B) Qualcomm ($15B), The Home Depot ($70B), The Walt Disney Corp($40B), Verizon ($110B), Visa ($96B).
So none of my “notables” dropped off the list, but it’s important to point out that only one of them has single digit revenues, and only and additional 3 would be under $50B in revenues.
I can already hear people yelling that profits matter, not revenue. OK, I’ll grant you that. Since my notable list didn’t reduce, let’s see if adding a third filter, earnings per share, does any pruning. Facebook’s diluted EPS for 2011 was $0.46. Setting the min bar to $0.45, and a max to $2.00, the 40 goes to 9, and here’s what’s left of my notables:
Amazon ($1.37), ATT ($0.67), Cisco ($1.17), Comcast ($1.50), GE ($1.23), Pfizer ($1.10) and Verizon ($0.85).
The only one of those with a PE multiple higher than the implied PE of Facebook (76 at the high end of it’s pricing range) is Amazon. No other company cracks 50, and only 3 are above 20:
ATT (47.8), Pfizer (21.1), Verizon (43.5).
My point in all of this is simply trying to highlight what should be painfully obvious. Risk.
Each of the 7 companies left in my notables list has a much reduced risk of their main line of product waking up one morning, deciding the company isn’t cool anymore, and moving on to the next thing. ATT and Verizon have that risk, but what they have going for them is the ability to point to the size and quality of their network infrastructure. They have hard assets like towers and land leases which are of limited supply, and difficult, if not impossible, to replicate, with incredibly high build out costs for competitors. Same thing with Comcast. GE – well they just make a ton of stuff. Cisco makes less stuff, but R&D is certainly a barrier. Pfizer – well the drug R&D budgets are legendary, and the process for getting FDA approval is an underfunded-company killer. Visa has incredible barriers to entry tied to fraud protection they have build, customer acquisition, and the network of businesses using their product. Paypal, Square and others are certainly making progress here, but it’ll be a while before Visa is really hurting. For obvious reasons, I can’t comment on Amazon.
The Facebook IPO is exciting, for sure, but I am getting really really nervous that we are setting expectations for our up and coming entrepreneurs in an unrealistic way. You’ll remember from my last post that I made the point that something is worth what someone will pay for it. I will not pay $35 for a share of Facebook stock given what I know about the financials published in the S1. I can hear the criticisms of this analysis, saying that Facebook is a new kind of company, blah blah blah. That’s incredibly self serving. Their primary asset is their customer base, which has lock in tied to data (pictures, connections, etc), but I am not sure I agree that cognitively a person would have a stronger connection to a company based on data stored there than they do with their mobile phone plan. ATT needs $114B in revenue to stay in my notables list – to Facebook’s $4B. Verizon has revenues of $110B. Both ATT and Verizon are valued around 45x PE, implied value to Facebook of $20.
For all those who say “well, with 800M customers, they will figure out how to monetize them later” – I don’t even know what to say to that. If you couldn’t figure it out at 100M, or even 500M, what is another X hundred million customers going to teach you? Comically, this reminds me of all those pitches to VCs in the late 90s: “the market has 1B people, and if I get just 0.1%, that’s 10M customers. Think of all that revenue.” That’s a pitch that would get you thrown out of any VC these days. Sadly, Facebook has actually acquired all of those customers, and are likely saying “if we can just get 0.1% to monetize at a higher rate…”
The real truth is that Facebook is worth what someone will pay for it, and the greater fool theory prevails here. Expect the stock to jump above $50 on day one.