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Andy Zaky is a Hedge Fund Manager at Bullish Cross Asset Management, and editor of the Bullish Cross financial newsletter. His main area of knowledge is in global macro economics, fundamental analysis and technical analysis. Andy has about 14 years of investment experience, a strong background... More
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  • The Case for a $50 Billion Facebook

    Like many privately held companies, Facebook has always been very tight-lipped about its financial performance only telling us that it went cash flow positive for the first time in September 2009, and that it’s user-base recently eclipsed 500 million subscribers. Yet, this doesn’t stop scores of Silicon Valley analysts from speculating on the company’s finances by evaluating the various trends in advertising revenue and user growth. Nor does it stop big investors from taking sizable stakes in the company in the hopes of getting handsome returns on a future IPO that some suspect could happen as early as 2012

    Based on a recent study released by eMarketer, Facebook is expected to bring in roughly $1.3 billion in revenue in 2010 nearly doubling the $665 million the research firm estimates it recorded in 2009. Yet, despite Facebook’s enormous revenue growth, it currently only brings in a meager $0.56 per 1,000 page impressions compared to the industry average of $2.43. Furthermore, according to current estimates provided by Second Shares, Facebook makes only about $2.60 per user on an annual basis, which is significantly lower than the $18 made by Google (NASDAQ:GOOG) or the $12 made by AOL (NYSE:AOL). 

    So while Facebook is poised to surpass Google with its 500 million users making it the most popular website on the net, some are concerned with Facebook’s ability to fully monetize its user-base, and question whether privately traded shares of the company might be overvalued. Facebook has yet to capitalize on its subscribers in a meaningful way and has made very little progress on the revenue per-user front.

    Yet, it's also important to remember that other Internet-based companies started in a similar way -- including Google -- and that Facebook could easily improve upon its anemic revenue per-user growth.

    While the company has no immediate plans to make a public offering, shares of Facebook already trade on two private exchanges attracting investors of the likes of Microsoft (NASDAQ:MSFT), Digital Sky Technologies and Chinese Billionaires. So what is Facebook really worth, and what might it be valued on IPO?

    According to Next Up Research, private investors were valuing Facebook between $11.1 and $12.5 billion earlier this year. Today, they're valued at $24.9 billion, according to a similar analysis offered by Bloomberg.

    And, according to Larry Albukerk, a specialist at EB Exchange Funds who privately brokers shares of Facebook, the company occasionally trades at an even higher valuation. “There are very large, sophisticated institutional investors who are buying at a $30 billion valuation,” he recently told MSN Money.

    Those are some big swings. Yet, Facebook investors are all too familiar with the huge volatility. When Microsoft (MSFT) took a $240 million sake in the company in October 2007, the purchase was based off a $15 billion valuation—the same valuation it had in early 2008 when Hong Kong billionaireLi Ka-Shing took the second of two $60 million stakes. But by 2009, Facebook’s value had dropped. A $200 million stake taken by the Russian technology firm Digital Sky Technologies in May 2009 put the company at a valuation of roughly $10 billion. That’s a $5 billion drop from the previous year’s valuation.

    So are private investors getting overzealous in their assessment of the company or will these large stakes prove as lucrative as those who had the vision to get ahead of Google’s IPO? The answer to that question largely depends on Facebook’s ability to monetize its user base. 500 million subscribers is a staggering number for any company especially when considering that Facebook already owns nearly half the world’s Internet users. Yet, as the financial community learned with YouTube, having a gaggle of users is only one part of the equation. The ability to make money on those users is key to determining value.

    When discussing this issue with senior analyst Debra Aho Williamson at eMarketer, I got the sense that Facebook will probably be able to monetize its user-base more efficiently in the coming years as a result of an impending shift in Facebook’s business strategy. That though half of Facebook’s current growth comes from the blockbuster success of its self-serve ad platform, its future lies with big-brand advertisers who are starting to show tremendous interest in being able to reach customers through the Facebook business model.

    Procter & Gamble (NYSE:PG), the world’s largest advertiser, continues to take a significant interest in Facebook, suggesting that other big brand names might soon follow. While Facebook’s self-serve ad platform has been responsible for much of its recent success, this pales in comparison to the type of revenue explosion Facebook will see from increased CPM rates offered by big brands.

    Secondly, according to Williamson, Facebook will soon see a significant uptick in user-growth through international markets, which is very key in making the overall platform attractive to brand advertising. As Facebook reaches more users world-wide, internationally recognized brand names are inclined to become far more interested in reaching its customers through this near universal platform.

    Despite the company’s massive install base, it’s still far outpacing Google’s growth in users. According to recent estimates, Facebook grew its user-base by 150% in 2009 versus Google’s 40% growth based on similar metrics. So even if the company doesn’t make immediate inroads in its CPM (cost per thousand page impressions) and CPC (cost per click) rates, user growth by itself is propelling much of the company’s 100% revenue growth.

    And even if Facebook doesn’t substantially raise its revenue per user in the immediate future, the company’s staggering user growth by itself justifies a valuation of nearly $50 billion over the next several years. Facebook is expected to earn nearly $1.8 billion in revenue in 2011 and that’s based on a projected 600 to 700 million users. Google currently trades at a $150 billion market capitalization and the only thing standing between Google and Facebook is Google’s revenue per user. If Facebook were to produce similar revenue per user rates as Google, the company could potentially be worth upwards of $150 billion.

    Finally, it is this potential to capitalize on such a huge user-base that will likely drive a lot of speculative demand for the company on IPO. Traders are already bidding the company up to $30 billion. In fact, when asking Paul Bard, director of research at Renaissance Capital, about the potential for a successful Facebook IPO, he noted, “Facebook could do an IPO tomorrow and the offering would be met with huge investor demand.” Renaissance Capital is the global leader in providing independent and investment management services on IPOs. Paul Bard, on his part, believes the company to be conservatively worth about $20 billion today.

    Based on my conversations with some of the leading analysts in the industry, I think what investors will likely see on Facebook’s IPO is a rally not seen since Google’s public offering. Many investors missed out in getting ahead of Google’s meteoric stock surge, and Facebook will give investors a second opportunity to participate in a blockbuster IPO. Facebook is probably already worth $50 billion, and will likely march toward the $150 billion valuation over the next several years. This article was originally published in an edited-down version at Fortune.

    Disclosure: At the time of this writing, the author holds no position in the equity markets. The information contained in this blog is not to be taken as either an investment or trading recommendation and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
    Aug 23 4:17 PM | Link | Comment!
  • Why Apple should hold-off on paying a dividend

     Toni Sacconaghi, an analyst with a questionable track record at Bernstein Research, wrote an open letter to Apple (NASDAQ:AAPL) urging the board of directors to return some of its growing cash hoard to its shareholders in the form of a dividend this morning.  Just as I began to believe Wall Street analysts couldn't get any more idiotic, Sacconaghi sends this highly misguided open letter to the board of directors at Apple (AAPL).

    Here's why Apple should at least hold-off on paying a dividend for a few more years.  Apple is currently trading at an elevated market capitalization that rivals the likes of Exxon Mobil (NYSE:XOM), and all indication points to Apple far surpassing Exxon to become the largest company in the United States in terms of market capitalization sometime in 2011.  For the market to have full confidence in Apple's market cap, Apple will have to show that though its net income isn't anywhere close to surpassing Exxon's in the immediate future, that its extraordinary cash position justifies a very large portion of its market cap.

    Yesterday, I published an article at Fortune explaining why Apple will probably trade at a $375 billion market cap in early 2012 compared to Exxon Mobil's (XOM) $315 billion market cap.  Now Exxon Mobil reports between $25 and $40 billion in net income yearly depending on the price of oil.  Apple, on the other hand, is expected to report about $18-19 billion in net income in 2011.  Yet, what drives the difference between Apple and Exxon is Apple's extraordinary cash position.  At the end of 2011, Apple will grow its cash from $45 billion to $70 billion or at a rate of about 40% on an annual basis.

    Exxon Mobil, on the other hand, reinvests a lot of its cash back into the business making its book value far more important in the analysis.  Exxon Mobil's book value stands at nearly $137.6 billion versus Apple's expected book value of about $73 billion at the end of 2011.

    So how will Apple justify a market capitalization that far exceeds Exxon Mobil when Exxon not only reports a higher net income than Apple, but holds a significantly higher book value?  Here's how.  Apple's growth rate in cash and net income far exceeds that of Exxon's justifying a higher valuation based on future growth.  By the end of 2012, Apple will likely exceed a $100 billion in cash and record net income that rivals Exxon Mobil.  By closing in on Exxon Mobil's level of net income and book value, Apple's market capitalization will be a lot easier for Wall Street to swallow.

    Source: Asymco

    Yet, if Apple starts to return a lot of that cash back to its shareholders, Apple's stock price will benefit in the short term from an elated sugar rush at the expense of Wall Street likely misconstruing the strength of Apple's balance sheet.  Having large amounts of cash on the balance sheet has always been key in demonstrating that a company deserves an elevated market capitalization because it's always easy to point to that cash as a basis for justification. 

    Furthermore, shareholders will derive a larger benefit from headlines that read "Apple exceeds $100 billion in cash" than headlines that read "Apple returns a few dollars to its shareholders."  Once the fact that Apple surpasses $100 billion in cash spreads across the financial industry, no one will question whether Apple should hold the #1 market cap.  This is very much an issue of perception.  For while Apple can accomplish the same result from a valuation perspective whether it does or doesn't offer a dividend, perception of valuation is far more powerful than what that valuation itself indicates.

    The more astute investor understands all too well Wall Street general ineptitude at valuation.  Almost no one disagrees that the market entirely failed in giving Apple an appropriate valuation under the relatively (un)complicated iPhone subscription accounting regime.  I fear that if Apple prematurely offers a dividend, Apple will see the same result as Wall Street grapples with difficulty of understanding cash flow.  

    Here's probably the most important piece of advice that I've ever given to anyone in finance.  Whenever being faced with two different ways to valuate a company, Wall Street will always choose the easiest of the two despite the more difficult method's accuracy and fairness in valuation.  Apple paying a dividend will force the majority of Wall Street into analyzing cash flow to justify market capitalization - something that requires more than total laziness on the part of the average large investor.

    Instead, what Apple should do is either offer a share buy-back program to reduce its market cap, or hold-off on offering a dividend until it surpasses $100 billion in cash.  This much is obvious.     

    Disclosure: At the time of this writing, the author holds September $46.00 puts on the QQQQ. The information contained in this blog is not to be taken as either an investment or trading recommendation and serious traders or investors should consult with their own professional financial advisor before acting on any thoughts expressed in this publication.
    Tags: AAPL, XOM
    Aug 12 3:04 PM | Link | Comment!
  • A Short Comment on Using Fundamental Analysis
    The editors at Fortune published a story I wrote for them today on a certain level of caution that investors should use when relying on fundamental analysis as a tool to make short or intermediate term price projections for Apple (NASDAQ:AAPL) or any other company. Though valuation proves very useful for making long-term predictions, history has taught us that patience is key when making investment decisions.

    Even today, Apple has been very range bound largely due to the sizable market correction that began on April 26 suggesting that Apple, like nearly every other company, is at the whim of the larger concerns of the broader market at least in the short-term. As I noted in the article, I'll be running a second piece on Apple's long-term valuation this week, but I had to stress just how important it is to have a long-term horizon on the company when relying on valuation as a basis for investment decision. So much so that it warranted a full article on the subject. You can read the full piece here.

    Disclosure: Disclosure: All Cash.
    Aug 09 1:55 PM | Link | 5 Comments
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