Everyone seems to be talking about the Facebook IPO, and their S-1 filing actual crashed the EDGAR website and prevented me from researching some actual value ideas, so I figured I’d go ahead and do a quick brush through the S-1 and my thoughts.
First up, I 100% agree with this excellent post over at Ragnar: at $100 billion valuation, Facebook is in bubble territory.
But here’s what I don’t get: Most bubble stocks are at least growing super, super quickly. And while no one is going to compare Facebook’s growth to our miserable GDP growth levels, try comparing its growth to the IPO everyone is comparing it to, Google (GOOG, Financial).
Check out Google’s revenue growth history here. From 2004-2005, they grew approximately 90% (from $3.2 billion to $6.1 billion), just a bit short of Facebook’s growth in the past year. The next year they grew under 75%, followed by approximately 57%, and then 31% from 2007-2008.
In other words, if Facebook follows Google’s path, the best of their growth days is well behind them. And you have to wonder if Facebook can even hit Google’s path. Google had the tailwinds of broadband internet and mobile internet access just starting to seriously penetrate households as they were growing. In other words, people were spending more time on the Internet, getting faster Internet (In the Plex mentions Internet access speed as critical to search usage levels), and more and more people were getting connected to the Internet! Additionally, perhaps most importantly, advertising revenue was starting to seriously shift to the Internet from other sources for the first time.
Facebook will have none of those tailwinds. It’s tough to see how much more time people could actually spend on the Internet. Facebook has already gotten most of the people it’s going to get (they already have approximately one-third of the world’s Internet using population, new user counts are rapidly falling, and most of the high-value users, who spend tons of time on the site, have probably already signed up) and likely driven their usage as high as it can get, and Internet speed is already far fast enough for loading web pages instantly. More and more advertising revenue will likely pour onto the Internet, but gains versus traditional media spend are likely to be incremental at this point.
In other words, I believe it would take outstanding execution by Facebook just to match Google’s growth rate.
Let’s see what happens if they match Google. Revenue starts at 3.7 billion and grows to $6.5 billion this year (2012), $10.2 billion in 2013, and $13.3 billion in 2014.
During Google’s growth spurt, EBIT margins went from approximately 20% to the low 30%, where they have remained. Facebook is currently at 50%, so it doesn’t seem like there’s much room for improvement, but let’s say they could get the same rate of improvement (50% margin improvement), so margins go from 50% to 75%. That seems a bit insane to me, given Facebook’s margins are already higher than just about every tech company I can think of, but let’s get crazy!
At 75% margin and $13.3 billion in revenue, Facebook’s 2014 EBIT would come in at under $10B. Using a 35% tax rate, net income would be a shade under $6.5 billion.
Google currently trades for a forward P/E (according to yahoo!) of 11.75x and an EV/trailing sales of approximately 4x. Apple trades for under 10x forward earnings and an EV/sales of approximately 3x. Both of them have significant net cash balances, so the market is actually valuing their core businesses at less than that earnings multiple, but we’ll ignore that for simplicity. Applying those multiples to Facebook would imply a valuation of $50 billion on the low end and approximately $70 billion on the high end. But remember, those are the valuations Facebook would deserve at the end of 2013/beginning of 2014 (assuming, of course, this rather rosy scenario comes to pass). Assuming a simple 10% discount rate for the next two years, Facebook would be worth closer to $41 billion on the low end and $58 billion on the high end.
In other words, we went through about the rosiest scenario we could imagine. We assumed Facebook followed Google’s growth rate. Google, of course, is perhaps the most successful growth story of our generation, and currently enjoys one of the widest moats in history, and had some huge secular tail winds driving growth that Facebook will not enjoy. We assumed massive operating margin increases, to a level that none of its competitors are close to achieving. And even doing that, I can’t begin to justify Facebook’s valuation at $100 billion.
So I’ll be staying away from it. I’d rather be invested in a bunch of old world net-nets or unloved, high yielding preferreds. Of course, if you follow this blog at all, you already knew that. And since you follow this blog, you likely are avoiding it too.
But good luck to the longs. I’d advise selling into the inevitable “pop” on the first day. I bet you it will be a massive one!
Disclosure: Long one Facebook account, one iPhone, and two Google email addresses.
First up, I 100% agree with this excellent post over at Ragnar: at $100 billion valuation, Facebook is in bubble territory.
But here’s what I don’t get: Most bubble stocks are at least growing super, super quickly. And while no one is going to compare Facebook’s growth to our miserable GDP growth levels, try comparing its growth to the IPO everyone is comparing it to, Google (GOOG, Financial).
Check out Google’s revenue growth history here. From 2004-2005, they grew approximately 90% (from $3.2 billion to $6.1 billion), just a bit short of Facebook’s growth in the past year. The next year they grew under 75%, followed by approximately 57%, and then 31% from 2007-2008.
In other words, if Facebook follows Google’s path, the best of their growth days is well behind them. And you have to wonder if Facebook can even hit Google’s path. Google had the tailwinds of broadband internet and mobile internet access just starting to seriously penetrate households as they were growing. In other words, people were spending more time on the Internet, getting faster Internet (In the Plex mentions Internet access speed as critical to search usage levels), and more and more people were getting connected to the Internet! Additionally, perhaps most importantly, advertising revenue was starting to seriously shift to the Internet from other sources for the first time.
Facebook will have none of those tailwinds. It’s tough to see how much more time people could actually spend on the Internet. Facebook has already gotten most of the people it’s going to get (they already have approximately one-third of the world’s Internet using population, new user counts are rapidly falling, and most of the high-value users, who spend tons of time on the site, have probably already signed up) and likely driven their usage as high as it can get, and Internet speed is already far fast enough for loading web pages instantly. More and more advertising revenue will likely pour onto the Internet, but gains versus traditional media spend are likely to be incremental at this point.
In other words, I believe it would take outstanding execution by Facebook just to match Google’s growth rate.
Let’s see what happens if they match Google. Revenue starts at 3.7 billion and grows to $6.5 billion this year (2012), $10.2 billion in 2013, and $13.3 billion in 2014.
During Google’s growth spurt, EBIT margins went from approximately 20% to the low 30%, where they have remained. Facebook is currently at 50%, so it doesn’t seem like there’s much room for improvement, but let’s say they could get the same rate of improvement (50% margin improvement), so margins go from 50% to 75%. That seems a bit insane to me, given Facebook’s margins are already higher than just about every tech company I can think of, but let’s get crazy!
At 75% margin and $13.3 billion in revenue, Facebook’s 2014 EBIT would come in at under $10B. Using a 35% tax rate, net income would be a shade under $6.5 billion.
Google currently trades for a forward P/E (according to yahoo!) of 11.75x and an EV/trailing sales of approximately 4x. Apple trades for under 10x forward earnings and an EV/sales of approximately 3x. Both of them have significant net cash balances, so the market is actually valuing their core businesses at less than that earnings multiple, but we’ll ignore that for simplicity. Applying those multiples to Facebook would imply a valuation of $50 billion on the low end and approximately $70 billion on the high end. But remember, those are the valuations Facebook would deserve at the end of 2013/beginning of 2014 (assuming, of course, this rather rosy scenario comes to pass). Assuming a simple 10% discount rate for the next two years, Facebook would be worth closer to $41 billion on the low end and $58 billion on the high end.
In other words, we went through about the rosiest scenario we could imagine. We assumed Facebook followed Google’s growth rate. Google, of course, is perhaps the most successful growth story of our generation, and currently enjoys one of the widest moats in history, and had some huge secular tail winds driving growth that Facebook will not enjoy. We assumed massive operating margin increases, to a level that none of its competitors are close to achieving. And even doing that, I can’t begin to justify Facebook’s valuation at $100 billion.
So I’ll be staying away from it. I’d rather be invested in a bunch of old world net-nets or unloved, high yielding preferreds. Of course, if you follow this blog at all, you already knew that. And since you follow this blog, you likely are avoiding it too.
But good luck to the longs. I’d advise selling into the inevitable “pop” on the first day. I bet you it will be a massive one!
Disclosure: Long one Facebook account, one iPhone, and two Google email addresses.
