Running Like Hell From The Facebook IPO

Feb. 2.12 | About: Facebook (FB)

So, I just went through the Facebook S-1 to take a look at what it said about the second most popular site on the internet. While I had figured that the company would fetch some lofty valuation, I thought "well, I shouldn't judge them before I actually look at the numbers..."

After reading through the filing, I thought "Anybody that would value this company at $75-$100 BILLION dollars is either stupid or delusional to the point of historically needing to have been put on trial." Ok, so, that might seem a bit excessive. But, lets take a look at it before anyone says anything too rash.

Let me be clear, I have no idea as to how to accurately predict the growth of the company hence, I am going to take it to the almost illogical extreme for this thought exercise. Presently, it seems that their ad revenue growth is slowing considerably. In 2009, ad revenue was $764 million. In 2010, its revenues from ads were up an impressive 145%, or, up to $1.686 billion. Then, in 2011, growth started to slow... to 69%, providing us with a total of $3.154 billion in ads sold. While there will certainly be a long term shift from advertising in print to the internet, Facebook (NASDAQ:FB) doesn't have a monopoly on ads. I highly doubt that they will ever have anything close to that. After all, Google (NASDAQ:GOOG) had over $36.5 billion in advertising revenues last year... more than 10x the amount of Facebook.

Facebook presently boasts 845 million active monthly users, which equates to $3.72 dollars in yearly ad revenue per monthly active user (based on a 2011 total of $3.154 billion in ads).

So, let's say that everybody in the world magically had a computer with internet access- presently, 6.8405 billion people. Now, let's also assume that they all develop the same usage as our present average monthly Facebook user and that companies were willing to pay Facebook the exact same amount for advertising as they presently do per user. Facebook would then generate $25.4466 billion in ad revenue (don't get me wrong, it's impressive, but, still not up to Google standards). If the company can keep the same margins of earnings related to the revenue (presently, ~21.2%: based on $3.154 billion in ads, which is slightly less than their total revenues, and $668 million in earnings for the A and B shares) then you are looking at a company that would earn just under $5.18 billion dollars a year.

Now, in what I don't think is a stretch to call an "overly rosy scenario", if the company is at that point valued at $75 billion, the stock would have a P/E ratio of ~14.5. If the company is valued at $100 billion, then the P/E ratio would become ~19.3. At that point, there would be very few ways for Facebook to justify a P/E that was at that level, unless you thought that they could juice margins, people will start spending a whole lot more time on Facebook (even though on page 3 of the prospectus, the company boasts that users upload 250 million pictures to the site PER DAY), we find an alien life form that would want to use the site, advertisers pony up more money for advertising on the site, or a few other various reasons. Maybe it gets infinitely cheaper for Facebook to add users in the future? But, due to how marginal cost works, I don't think that will last forever. Besides, its margins are already about as hefty as Google's!

Regardless, anyone buying the stock had better have some really good insights as to how the company can grow, because if the news stories are right in regard to its coming market price, it will be trading between 112x and 150x 2011 earnings. In the meantime, I will stick to stuff that I have a very high degree of certainty is cheap and pass up any chance that I get to buy shares of Facebook on the open market. When comparing Facebook to Google, it almost seems like a bet on Facebook is not only a bet for Facebook, but also a bet against Google. Remember, Google has over 10x the ad revenue of Facebook, nearly 11.5x the cash on hand, and is nearly 15x as profitable, with a market cap that is ~2x what Facebook's is expected to be.

The bottom line seems to be this, Facebook is going to need to figure out alternative ways to make money; ads just won't cut it to justify the stock price that has been predicted.

Good luck to all of you buying shares in the IPO.

Disclosure/Disclaimer: I have no financial position or interest in or against, in any regard, to any of the entities mentioned. This is not advice of any kind. Always do a ton of your own research before contemplating doing anything that I say, do, write, or so much as think about.