In the first week of trading, Facebook (FB) is now down more than 25% from its initial open price of $42 per share. This comes on a week when the Nasdaq had a 3% rally. Yet still, with a valuation on Facebook at above $90 billion or 24X revenue, it is nothing short of ridiculous! Add that to the fact that it is all just plain selling & there are no options or borrowable shares available to short until May 29th and you have an equation that results in a Facebook stock that is still going to go much lower over the coming months.
Additionally, the current float of Facebook's stock is only about 1/7th of the total number of shares outstanding. This is due to the fact that the insiders like Mark Zuckerberg (owns roughly 22% of the outstanding shares) are in a lockup for 91 days. If you take a step back and look at why Facebook went public, it is not hard to see what is going on here.
There are only 4 reasons a company would ever go public:
- They want to raise capital to expand
- To clean up their balance sheet, usually in relation to an excess of debt.
- So the insiders and original investors can liquidate and "cash-out."
- Because of the 500 shareholder rule that states you can only have a max. of 500 investors as a private company without having to file your financials with the SEC.
So which one of these reasons meets Facebook's criteria? If you break them down one by one, knowing that founder and majority shareholder Mark Zuckerberg fought off pressure to go public for many years, the answer is clearly #4. It no longer made sense to be a private company as Facebook would have to now disclose all of their financial records with the public anyways. Mark Zuckerberg knows how tech bubbles are created, and if he had it his way, he would never have taken Facebook public. But because of the 500 investor rule, they were forced to IPO, which always puts a lofty company at great risk for the start of a bubble.
With Facebook being another very sexy and trendy tech IPO, with quarterly revenue growth of over 40%, I am not going to focus on EBITDA growth as we would for any other Nasdaq-listed stock, but focus on the valuation based on the multiple of its revenue. Facebook is currently trading at 24X yearly revenue. To compare to other sexy tech giants, Apple (AAPL) trades at 3.7X revenue and Google (GOOG), a more similar revenue model to Facebook, trades at 8.25X revenue, making both these names significantly cheaper than Facebook.
After seeing the Facebook IPO perform so poorly, it is clear that the underwriters significantly overvalued the company. Think back to the internationally renowned film The Social Network, which was in theaters just over a year ago. At the end of the movie, up popped on the screen a line that made everyone's jaws drop and eyes open. It read, "Today, Facebook is worth $25 Billion." This line was mind-opening to all Facebook users and had many people on the street doubting, even then, that Facebook was worth $25 billion. Fast-forward 18 months and now you have Facebook with year-over-year earnings growth declining 12% but somehow is being priced in its initial public offering at $104 billion.
The only conclusion to make as to how the enterprise value of Facebook has increased by over 300% since The Social Network is that investors are pouring their money into the pool, and thus, tangibly making the intrinsic value of the company's intangible assets grow larger and larger. And if that's the case, this thing is going to bubble harder than the U.S. housing market in 2006.
With all the negatives surrounding the execution of the Facebook IPO, specifically in the valuation of the company, the one positive is Facebook was in fact successfully able to raise an additional $16 billion in cash. However, there is no way that Facebook is going to be able to hold its current valuation with its current business model. The precedent here is Google, which also IPO'd into a very lofty valuation, but was able to grow into that valuation as they expanded their revenue model into other fields, most notably the mobile phone and video streaming markets with its acquisitions of Android and YouTube.
In the midst of General Motors (GM) dropping Facebook as an advertising platform, there is no doubt Facebook is going to try to follow the path of Google and start to make acquisitions. With Google being the revenue blueprint, slowing companies like Netflix (NFLX) and Research in Motion (RIMM) (BlackBerry) are very likely targets.
We feel that the uncertainty of Facebook's advertising platform (following the loss of the General Motors contract), combined with the inevitable acquisitions made to move into new revenue markets, signals a lot of confusion on the future of Facebook's overall revenue model, which will result in questionable and vague guidance. In a growth company as trendy as Facebook, vague guidance and acquisitions always results in downside pressure, and we look for Facebook's valuation to come back down to Earth over the coming quarters, similar to the way Groupon's (GRPN) stock performed in the first few quarterly reports following its IPO. (Note: Groupon is now down over 60% from its IPO high.)
In our opinion, all of this leads up to the certainty that the original shareholders, such as Mark Zuckerbeg, Peter Thiel, and the now infamous "tax-dodger" Eduardo Savarin, will almost definitely be looking to cash out a significant portion at current valuations as soon as their lockup is up August 20th. As we mentioned above, only 1/7th of the current shares outstanding are in the float, mainly due to this lockup, so expect major dilution on the stock itself as their shares come into the market.
We do not see any reason to value the business any higher than the $25 Billion valuation put on the company in the credits of The Social Network.
Add to that the $16 billion cash raised in the IPO, and Facebook stock should have a market cap of $41 billion, or roughly $15 per share.
We have decided not to include any consideration into the old saying "a company is worth what someone will pay for it" into our valuation because, with almost half of the IPO going to existing shareholders, we believe there were an abnormally high number of mid- to high-net-worth retail investors participating in the $38/share or $104 billion valuation IPO, who we do not consider to be credible.
The big investment banks and Zuckerberg played these retail investors for fools on this IPO. They sold so much stock in the IPO & allocated so much to individual investors that it was doomed to go down. Other IPOs, like LinkedIn (LNKD), Zynga (ZNGA), Yelp (YELP), etc. were "hot" because they sold such a small percentage to the markets which were all scooped up by institutional funds.