Since Facebook (FB) debuted on the Nasdaq at $38 on May 18th, 2012, the stock has plunged as of the time of my writing this to $25.84, or a staggering 32% in just a few weeks. If you miscalculated and didn't sell at a higher intraday price than that at which you bought it, this post may help to explain why you have lost money on your investment, and what you may have to expect going forward.
To the question posed in the subject heading, the answer is simple: the fundamentals of the business in no way justified the final offering price of $38, except in a bubble or mania environment. And no prudent fundamental investor should pay mania or bubble prices for stocks. I cannot explain to you exactly why or how the offering price got so high, but it was an artful and, some might say, avaricious achievement on behalf of the stock's underwriters and selling shareholders. If you are now left holding the bag, and wondering what to do, it behooves you to see this cursory evaluation of the fundamentals and valuation below, so that you can come to your own conclusion about what a fair price to pay for Facebook is.
First, let's look at Facebook's revenue growth, and specifically, let's look at the second derivative of its growth in a granular way. When the question was posed to me about whether or not Facebook seemed like a good value at its IPO price of $38, I started by looking here, at actual revenue growth over the last few quarters, to get a sense of the trend.
Facebook Total Revenue Growth (millions)
| Time period | 1q11 | 2q11 | 3q11 | 4q11 | 2011 | 1q12 |
| Revenue (mm$) | 731 | 895 | 954 | 1131 | 3711 | 1058 |
| Y/Y Growth | 111.9% | 107.2% | 104.3% | 54.7% | 87.9% | 44.7% |
| Q/Q Growth | 0.0% | 22.4% | 6.6% | 18.6% | -6.5% |
If the deceleration in Facebook's revenue growth, both on a sequential and year-over-year basis is apparent to you, good! It stood out to me as well. Y/y growth has been cut in half since 3q11, and has headed in the wrong direction since. While analysts often underestimate revenue growth for IPOs (the "beat and raise" phenomenon is often a great way to boost a stock's price), the consensus '12 revenue estimate on Thomson First Call is at $4.960 billion, representing 33% y/y growth. That suggests a further deceleration from the most recent quarter's 44.7% rate. In other words, the analysts are, for now anyway, expecting growth in Facebook to slow more as time goes by. In this case, I find these estimates to be more believable than other IPO estimates, because the trend for the last five quarters supports it, as opposed to contradicts it.
This gets me to my next point: we can now think about Facebook's revenue and earnings growth in the context of a couple comparable companies, and tie it to the stock's current price, to get a sense of valuation. Let's use this in a brief comparables analysis with LinkedIn (LNKD), Google (GOOG), and Zynga (ZNGA).
| LNKD | GOOG | ZNGA | FB | |
| Price | 92.49 | 579.05 | 6 | 26.23 |
| Diluted Shares Out (mlns) | 111.31 | 330.1 | 707.69 | 2201 |
| Mkt Cap (mlns) | 10,295 | 191,144 | 4,246 | 57,732 |
| 12 Rev Ests (mlns) | 908.95 | 35338.3 | 1448.81 | 4960.98 |
| 11 Rev Actuals (mlns) | 522.19 | 29094 | 1155.51 | 3711 |
| 12/11 Projected y/y Growth | 74.06% | 21.46% | 25.38% | 33.68% |
| 11 EPS | 0.35 | 36.04 | 0.24 | 0.43 |
| 12 Est. EPS | 0.68 | 43.27 | 0.27 | 0.54 |
| 12/11 Projected EPS Growth | 94.29% | 20.06% | 12.50% | 25.58% |
| P/'12 EPS | 136.01 | 13.38 | 22.22 | 48.57 |
| PEG | 1.44 | 0.67 | 1.78 | 1.90 |
| Price to '12 Sales | 11.33 | 5.41 | 2.93 | 11.64 |
| P/S/Growth | 15.29 | 25.20 | 11.55 | 34.55 |
As you can see here in the far right column, Facebook is still trading at 48.5x '12 EPS, with a PEG of almost 2. Most analysts would see this, if the estimates are to be believed, as a sign the stock has more to fall because a PEG of 2 is not considered cheap (as a rule of thumb, a PEG of 1 is considered "fair" and, at less than that, it becomes a valuation metric suggesting a possible undervaluation of the stock, so Facebook is still double that of a "fair" valuation). There are many different ways to slice the valuation, however. Price/Sales metrics have often been used for companies in the hyper growth phase, either because revenues are growing very quickly and EPS have not "settled down" or because some companies with very fast revenue growth still have negative EPS. It's hard to argue that Facebook is still in the hyper growth phase with just 33% revenue growth projected, versus, say, LinkedIn's at 74%, but let's assume it is for rhetorical purposes. FB's P/S metric is slightly higher than LNKD's, even though LNKD is growing revenues at twice the pace of FB. FB's P/S metric is 2.15 times and 3.97 times the P/S metric of GOOG and ZNGA, respectively. This suggests a massive overvaluation in terms of P/S with respect to these comps.
In short, even after FB's precipitous drop since its IPO, I just can't find any basic valuation metric that makes it seem cheap yet compared to the stocks I've mentioned above.
In my opinion, though hype can drive the price of a stock higher or lower in the very short run, earnings are what drive the valuation of a stock in the long run. As such, I propose you view a somewhat generous valuation of FB with a PEG of 1.44, which is equal to that of LNKD's. As such, we get $19.89, close to the $20 many other columnists and professionals have used as a goalpost.
To me, though, I don't want to buy at a price that doesn't assume some kind of negative news built in, in order to provide my purchase with a margin of safety. To that end, I don't think I'd be interested in considering FB as a long unless it were somewhere in between a PEG of 1 (25.5*.54) and 1.44 (25.5*1.44*.54), or $13.77 and $19.89. Conservatively, I'd be more keenly interested in it at below a price of $13.77, assuming the earnings estimates are correct.
And for those of you who feel comfortable shorting stocks, and think FB could provide an opportunity to profit in this way, Morgan Stanley (MS) is now joining Goldman Sachs (GS) and JP Morgan Chase (JPM) as a lender of the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
