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Will Facebook Soar Like Google After Its IPO?

February 02, 2012 | About:
Holly LaFon

Holly LaFon

259 followers
Facebook’s IPO is creating quite a stir recently. Valued at $100 billion, it would be the largest Internet IPO ever. On the surface, Facebook has much in common with another major Internet IPO of the decade, Google. They are both hugely popular and profitable internet companies who rely heavily on advertising for revenue, with grandiose, global-reaching goals: Google has said it aims to “provide a great service to the world— instantly delivering relevant information on any topic.” Facebook’s stated mission is to “make the world more open and connected.” But there is a great disparity in their ability to create sustainable growth for shareholders. Google’s (GOOG) net revenue growth leading up to its IPO in August 2004 was astronomical. It jumped from $19 million in 2000 to $962 million in 2003. Earnings grew from a net loss of $15 million to a net gain of $106 million, in the same span of time. Facebook has grown at a similarly rapid rate, increasing revenue from $777 million in 2009 to $3.7 billion in 2011. Earnings grew from $229 million to $1 billion in the same span of time.

While Facebook has explosive growth, it has several distinct challenges. First of all, Facebook is already reaching penetration and the pace of growth could decelerate in coming years. In Chile, Turkey and Venezuela, for instance, more than 80% of Internet users use Facebook. In the U.S. and UK, Facebook has a penetration rate of approximately 60%. There is still room to expand abroad, with a penetration rate of just 20-30% in countries such as Brazil, German and India; Japan, Russia and South Korea is less than 15%. Facebook access is still restricted in China.

Facebook says it aims to make all two billion global Internet users members of its site, but the nature of its business makes this unrealistic. There will always be a significant portion of the population with no interest in getting on a website to “Like” their friends’ statuses or see what their high school classmate from 40 years ago had for breakfast.

Still others defect from the site every day, overwhelmed by the constant changes, finding it interfering with other priorities, or losing its utility once they feel restricted in what they can say knowing their parents or coworkers can read and see everything they post. A recent Pew Internet & American Life Project study found that the twice as many teens aged 12 to 17 are now using Twitter from two years ago, seeking a haven of privacy. This has also strengthened the appeal of Google+, which has circles of privacy people can add various friends to.

Along with financial valuation, one of the most important aspects of an investment is how much society will value the company. Google and Facebook are different in this respect as well. There will always be alternatives to Facebook to connect with people. Members can stop using Facebook and still call, text, email, or see their friends in person, with little disruption to their social lives. Few people, however, will stop using Google to look up information and instead revert to picking up the right letter of an encyclopedia set. Businesses, individuals and schools will continue to use Google to navigate the vast resources of the Internet, as well as the company’s many other innovations.

Valuation of the Facebook and Google IPOs would not give useful information about their futures. At the time of Google’s IPO, it had a P/E of 195 and P/S ratio of 21.3. The business has grown significantly since then and the P/E has come down to 19.65. Facebook’s IPO P/E, if they value the company at $100 billion, will be 100, and the P/S will be 27.



Google, on the other hand, is valued at nearly $200 billion, but generated nearly ten times Facebook’s revenues and about six times its profit. As GuruFocus author David Dietz writes, “If Facebook is really going to be the next Google (GOOG), its value is closer to $33 billion, one third of projections.”

He also notes that Google, with a 20% per annum growth rate and P/E of 20, has a PEG ratio of about one. A PEG of one applied to Facebook would require that the company grow earnings 100% annually to justify a 100 P/E ratio.

Facebook does not seem like an appealing investment for value investors. But most value investors steered clear of Google when it went public as well. One exception was Bill Miller. He was in on Google’s IPO near the end of his winning streak which ran from 1991 to 2005. Undeterred by the high valuation, Miller got the stock at $85 and watched it soar to $436 a year and a half later. Then for the next six years he underperformed the S&P and ultimately resigned from his fund, reinforcing just how cloudy the future of an Internet company can be.

Facebook seems as though it has less going for it than Google did at this point, and whether it will follow the same trajectory depends greatly on several unknown factors about the future.


Rating: 4.3/5 (13 votes)

Comments

mo77
Mo77 - 2 years ago
Excellent article.

I feel that Facebook and all it's mini-mes (linkedin, zynga, zillow) are the latest fad.


Mark Twain said history doesn't repeat itself but it rhymes.

The love affair w/ social networking companies echoes earlier iterations. In the 50's there were airline stocks, In the 60's there was the conglomerate craze, In the late 90's, there was dot.com & in the last decade the clean energy love affair .

There is no question that there are great companies w/ these new industries (Facebook being far and away the best), but an investment in a great company at a ridiculous valuation is a horrible idea.

My feeling is ultimately, owners of the vast majority of these stocks will incur permanent impairments once their underlying businesses are re-valued properly.

Facebook will probably best last of the dominoes to fall, but it too will ultimately face the gravity of earnings.

I could be wrong (God knows that's a frequent occurrence). But for me, it lacks a margin of safety.


valueradar
Valueradar premium member - 2 years ago
Compare with Facebook and Google, Google certainly helps people to increase productivity; Facebook probably has a negative contribution to the overall productivity of the society. It always puzzles me that why people waste so much time to Facebook.

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