Much has been written on the issues surrounding the Facebook (FB) IPO and I will not rehash them here. The fact is FB is now a public company with a valuation determined by the public markets. At its current price of $32 per share, FB has a market capitalization of ~$77 billion and an enterprise value of ~$55 billion. On all traditional valuation metrics, this is a lofty valuation. It is 15x 2011 sales and 11x Wall Street research's consensus 2012 sales estimate of $5.1 billion, which represents sales growth of 37% over 2011. On an earnings basis, FB is trading at 58x consensus 2012 EPS and 46x consensus 2013 EPS. The consensus estimates imply annualized earnings growth from 2012-2015 of 33%, hardly a growth rate that supports a 50x earnings multiple.
At the core of the FB valuation debate is growth. The projected 37% growth rate for 2012 sales is significantly lower than the growth FB has experienced to date. From 2007-2011 FB grew sales at an annualized rate of 122%. In 2010, FB grew sales 136%. In 2011 FB added another 88% in sales growth. In the lead up to the IPO, FB announced Q1 2012 sales and the growth was only 45%. This number was a disappointment. Was this a pause in FB's growth trajectory or a permanent shift to lower growth rates? FB usage is shifting from desktop to mobile device, which makes monetization more challenging. To date FB has not focused on mobile monetization and how well the company can monetize mobile once it decides to focus is difficult to predict.
The year-over-year quarterly sales growth rates for the past 5 quarters show an alarming trend that is likely the result of the mobile migration:
FB's high valuation combined with a slowing growth profile creates a dangerous dynamic for investors. There will be a tremendous amount of focus on Q2 2012 earnings, which Bloomberg estimates will be announced in late July. It will be FB's first earnings announcement as a public company and every word in the press release and on the conference call will be highly scrutinized.
Investors should be very wary of buying FB stock before announcement of Q2 earnings because the risk/reward dynamic is skewed. Any data or commentary that suggests that FB can monetize mobile and reinvigorate its growth profile helps justify its current valuation, while the lack of such positive commentary could lead to a significant downward revaluation of the stock. If you believe in FB's long-term potential and consider quarterly earnings far too short-term oriented, you should hope for a negative market reaction so you can purchase shares at a discount to the current price. The downside potential significantly outweighs the upside and investors should wait and reassess FB's valuation post Q2 earnings.