The surprise of George Soros (Trades, Portfolio) buying coal stocks in the second quarter has largely overshadowed another significant development for the investor – the purchase of his largest Facebook (FB, Financial) stake to date and the sale of Alibaba (BABA, Financial), a relatively quick change from when he did almost the opposite with the companies just a few quarters ago. Though Soros has vacillated on the two online giants, both appear overvalued.
Facebook and Alibaba
Though both companies operate primarily in the online space, they have many differences. Facebook focuses on social media while dabbling in other products such as the abortive Facebook phone and acquiring other social media-related businesses such as WhatsApp and Instagram. More recently, in March, it proved it would venture into search and e-commerce with the purchase of shopping search engine TheFind.com.
Soros praised social media’s meteoric rise in the U.S. in an article for the New York Review of Books: "In recent years the U.S. has led the world in the innovative development of social media, while China has led the world in finding means to control it," he said.
China’s Alibaba, by contrast, tries to do almost everything: retail shopping, auctions, stores, positioning services for the military, cloud and data management, online payment and even banking.
As recently as third quarter 2014, Soros saw opportunity in Alibaba, buying 4.4 million shares, a stake then valued at more than $390 million. By November Alibaba had soared to more than $119 per share from its September IPO of $68 per share.
But the stock picture quickly paled, as the price slid 33% this year to just above its initial offering price, at $69.47 Friday. In the second quarter, Soros removed 99% of his Alibaba shares from his portfolio as the price dropped.
Also in the third quarter of 2014, Soros sold out most of his Facebook stake he had started the prior quarter, chopping 86% of his 1,841,260 shares.
After reducing further over the next two quarters, Soros then increased his Facebook position by 1,988% to 2,591,407 shares – his largest holding of the company to date – in the second quarter this year as the price continued to rise. The increase boosted Facebook to 2.3% of his portfolio and raised it to the seventh largest of his 252 holdings overall.
Valuation
Baron Funds founder Ron Baron (Trades, Portfolio), who is bullish on Facebook, wrote of the company in August:
“Facebook Inc. is pioneering a new age of people-based advertising – targeting relevant ads to actual people or audiences, not content. In the United States, during 2014, mobile accounted for 24% of consumer media time, but only 8% of advertising spend. Facebook accounts for a full 20% of mobile time spent in the U.S. The ‘catch up’ of ad spend to media time provides a powerful secular tailwind to Facebook and other mobile-centric advertising platforms.”
But both Alibaba and Facebook have several markers of being expensive. Facebook has a P/E of 96.3, P/S ratio of 18.1 and P/B ratio of 6.2. Alibaba also has a P/E ratio of 28, P/S ratio of 13.9 and P/B ratio of 5.87. Both of their valuations far exceed the average S&P 500’s P/E of 19.2, P/B of 2.8 and P/S of 1.8.
Facebook’s P/E ratio, however, is close to a one-year high, while Alibaba’s is near the lowest point in its history.
Both of the companies have extraordinary growth rates, far outpacing their industry peers. Facebook has a three-year average revenue growth rate of 49.8%, compared to 28.9% for the industry, and average net income growth rate of 43.3%, compared to 24.1% for the industry.
Alibaba has grown revenue at a three-year average rate of 56.1%, compared to 13.3% for the industry, and net income growth rate of 79%, compared to 4.7% for the industry.
The two companies have strong gross margins, with Alibaba at 68.7% for 2014, though this marked the second lowest rate in its 10-year financial history.
Facebook, meanwhile, showed an 82.7% gross margin for 2014, the highest in its five-year available financial history.
Soros, primarily a macro investor, went with the higher margin, more expensive company, though the underlying fundamentals indicate that both companies come at ritzy valuations.
The S&P 500 Tech Sector was the second worst performing sector of the week, down 3.3%, with Facebook down 5%.
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