With all of the hype surrounding Facebook (FB), investors would be wise not to rush over to a punch bowl that has already been drunk. Rather, internet media investors should consider backing companies that have real penetration potential. Facebook is near its saturation point and, in my view, ready to collapse as the social networking craze comes to an end. The business model has been ephemeral since day one and, with a valuation of around 100x past earnings, a lot of growth is necessary for justification.
Google (GOOG) is one rival that, despite being a mature company, has plenty of potential. I think that its version of social networking - Google+ - is also sustainable in the context of search engine implementation. The company has plenty of additional value drivers that can boost the stock price: Android, YouTube, and even Google X. Put differently, investors are not factoring in its earnings power and projection. Baidu (BIDU), however, is overpriced even with high double-digit growth.
In this article, I will run you through my DCF model on Baidu and then triangulate the result with a review of the fundamentals against Google and Yahoo (YHOO).
First, let's begin with an assumption about the top-line. Baidu finished FY2011 with $2.25B in revenue, which represented a 92.1% gain off of the preceding year: acceleration. I model per annum growth trending from 50% to 25% over the next half decade or so. This is exceptional growth that implies revenue being more than 23x where it stood in FY2009. For the sake of proving my point, however, I am implementing the projection.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 23% of revenue versus 25% for SG&A, 9.3% for R&D, and 7% for capex. Taxes are estimated at 15% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I model this hovering around -2% over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $124.98, implying 13.6% downside.
All of this falls within the context of strong momentum:
"In the final quarter of 2011, we delivered strong financial results, driven by our relentless execution and ability to capitalize on exceptional market opportunities. Overall, 2011 was an extraordinary year for Baidu with strong financials and encouraging progress".
Again, however, all of this earnings power has been overly priced into the stock, as evidenced by the 48.1x PE multiple. By contrast, Google and Yahoo trade at a respective 18.2x and 17.4x past earnings. I believe that Google's higher multiple relative to Yahoo is justified in light of the company's strong brand, broad diversification, and leading management. If anything, the premium is too low.
Consensus estimates for Yahoo's EPS forecast that it will grow by 12.2% to $0.92 in 2012 and then by 16.3% and 13.1% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $1.03, the stock would hit $16.48 for a negligible amount of upside. In light of (1) the hype surrounding Facebook, (2) overly aggressive growth expectations for Baidu, and (3) limited opportunities for Yahoo, Google is likely to be a strong outperformer.
Since I take a long-term view on the stock market, I wouldn't recommend shorting Facebook (when it goes public), Baidu, or Yahoo - only consider doing so from a theoretical framework. While I don't expect greater optimism emerging for these companies, their growth rates may end up being much higher than what I expect (although I have tried to be reasonable with the assumptions.) Actually, there are a few good bullish cases for these Internet companies circulating here on Seeking Alpha. But, in a world where I am weighing peers, seeing only black and white, and choosing winners, my money is solidly on Google.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
