They say insanity is doing the same thing over and over again and expecting a different result. Tech Buble meet Facebook.
Facebook is on the verge of ushering in the largest IPO ever. FB plans to offer 337 million Class A shares at between $28 and $35 per share. At the high end of that range, and adding in other outstanding shares, you arrive at a valuation just shy of $100 billion.
Last year the company’s net income was about $1 billion.
At a $100 billion valuation, Facebook’s price-to-earnings ratio would stand at 100. In other words, at current earnings it would take investors 100 years to earn back their investment.
Google stands at a P/E of 18.
Apple’s P/E sits at 14.
The case for the valuation is that Facebook’s growth will be nothing short of phenomenal. In other words, investors are betting that Facebook will grow into its valuation.
Such a theory is not unprecedented. Google’s P/E at its IPO was 195! Google’s stock was priced at $85 at its IPO, soared to $600 in 2007, fell to the mid-$400′s in 2009, and today sells for about $600. My guess is that if you bought at the IPO and still own the stock today, you’re pretty happy.
The same could happen to Facebook. But it’s not a smart bet for several reasons.
First, Facebook’s momentum has already started to slow. During the first quarter of 2012, its revenue grew at a 45% pace as compared to a year ago. That’s growth most any company would love, but a far cry from the nearly 90% growth it enjoyed a year earlier. And its profit actually fell 12% from a year earlier.
Second, 85% of its revenue comes from advertising. If Facebook is going to grow into its valuation, it will need to expand its other revenue streams. As you’ll see below, its growth in the U.S. has already started to slow, where a lot of advertising dollars are spent. And its advertising platform just can’t compare to Google’s.
We use search engines to find and buy stuff, so ads are a natural fit. Facebook is still about connecting with friends and family. Is there a place for advertising on Facebook’s platform? Of course. Does it justify a $100 billion valuation? No way.
Third, Facebook is running out of potential customers. According to its S-1 filed with the SEC, it has about 900 million users. The same filing tells us that there are about 2 billion internet users worldwide. If they can double their users, they’ll have to expand to another planet to find more growth.
Facebook has already saturated markets like Chile, Turkey, and Venezuela where FB estimates penetration rates of greater than 85%. And check out this chart taken from its S-1:
The overall growth of monthly users is impressive. But notice how growth has already started to slow in the U.S (second row graph on the left). Consistent with these charts is that Facebook’s revenue from outside the U.S. has been growing. But the saturation in the U.S. does not boad well for the scale FB needs to achieve to justify its valuation.
Still, it will no doubt be a feeding frenzy when the opening bell rings. Paul R. La Monica of CNN The Buzz fame put it best–
Of course, none of my skepticism will make a difference when Facebook starts trading. The demand for the Facebook IPO will probably be so hot that investors will buy first and ask questions later. The $5 billion worth of stock Facebook plans to sell is a tiny amount.
“Given the small float and scarcity factor, everybody will want a piece of the action,” Loughran said.
But mark my words: Valuations still matter. Eventually, Facebook will have to trade at a price that’s more in line with its peers.
But if you are just dying to buy Facebook shares, there’s good news for the small investor. Lat last Thursday Facebook added E*Trade to its list of underwriters. If you want Facebook IPO shares, E*Trade is your answer.
And speaking of Facebook, do you mind heading over to the Dough Roller Facebook page and giving it a like? FB might not be worth $100 billion, but 900 million users is nothing to sneeze at!
Published or updated March 26, 2013.