Facebook's Valuation Seems Socially Unacceptable

| About: Facebook (FB)
This article is now exclusive for PRO subscribers.

I really haven't thrown myself into all of the hype regarding Facebook since it went public. Should you buy, should you short, what should (NASDAQ:FB) you do? I wanted to let the stock settle down a bit and then evaluate it. Well, today, I am here to do just that. I'm going to examine Facebook's expected growth potential, compared to other names in the space, and determine whether the valuation fits.

For purposes of this argument, I am going to compare Facebook against LinkedIn (LNKD), Groupon (NASDAQ:GRPN), Zynga (NASDAQ:ZNGA), and Pandora (NYSE:P). For this discussion, I am going to look at the price to sales and price to earnings ratios. For price to sales, I am using the market cap given based on the current amount of shares outstanding. For example, Facebook currently has 2.14 billion shares outstanding. We know that there are a bunch of employee and executive stock options outstanding that could bring that share count up to 2.5, perhaps even 2.8 billion, according to some rumors. I am not counting those options here, and if I did, it would make the valuation look even worse. I'll analyze the numbers I've calculated first, then give the opinion of current analysts on the street.

First, I'm going to look at expected growth. When analyzing an investment, you want to know what you are getting into. All of these internet names are growth oriented names, so it only makes sense to look at revenue and earnings growth. The following table shows the currently projected revenue and earnings growth for this year and next. All companies except for Pandora use a calendar year for their fiscal year. Pandora's year ends in January so the "2012" year for them is the one ending January 2013.

2012 Revs 33.5% 74.1% 25.4% 47.7% 54.9%
2013 Revs 30.8% 48.8% 21.2% 29.0% 43.4%
2012 EPS 25.6% 94.3% 12.5% N/A N/A
2013 EPS 20.4% 79.4% 37.0% 288.9% N/A

*Groupon expected to swing from 72 cent loss in 2011 to 18 cent profit in 2012. Pandora expected to lose 2 cents in 2012 after an 11 cent loss in 2011. Pandora expected to swing to 5 cent profit in 2013 fiscal year (ending January 2014).

As you can see, Facebook offers the second lowest amount of expected revenue growth for the two year period. Only Zynga is lower, and Zynga derives a majority share of its revenues from its games that are on Facebook. Facebook and Zynga are also at the bottom when it comes to earnings per share growth. LinkedIn leads in both categories.

Now let's look at where the valuations stand, again based on the expectations for 2012 and 2013 fiscal years.

P/S (2012) 11.15 10.57 2.91 2.63 4.00
P/S (2013) 8.54 7.12 2.40 2.04 2.79
P/E (2012) 47.91 136.76 21.22 54.39 N/A
P/E (2013) 39.80 76.23 15.49 13.99 205.60

In terms of price to sales, Facebook is the most expensive stock, way above most of the other names. When you look at 2013, the stock appears extremely overvalued. Don't forget, if all of those executive options are exercised, more outstanding shares would mean an even higher market cap, so the valuation would be even worse. Now, when you look at price to earnings, Facebook is still expensive, although it appears that LinkedIn is even more expensive. Remember though, LinkedIn is cheaper on a price to sales basis, and LinkedIn offers a larger amount of growth, when it comes to both revenues and earnings. I don't think Facebook currently justifies the valuation at trades at, meaning I think there is more room to the downside.

So my opinion is that the name is overvalued. Let's see what the analysts think. The following table shows the average rating (1.0 = strong buy, 5 = sell) for each name. It also shows the average price target for each, and the corresponding upside that represents from Monday's close. Now, remember with Facebook that the underwriters are not able to publish their reports on the name yet, so we'll be getting more opinions on Facebook over the next few weeks and months. Given that the underwriters may have taken their numbers on Facebook down right before the IPO, it will be interesting to see what they have to say.

Analyst Opinion 2.4 2.4 2.4 2.6 2.3
Average Target $38.75 $128.76 $12.83 $18.12 $13.56
Upside 49.79% 38.45% 123.91% 85.09% 31.91%

Analysts view Facebook about the same as the others, but again, we haven't heard from the underwriters yet. In terms of upside, each of these names appears to have plenty of potential. The question is, can these names actually produce the revenues and earnings that are expected of them? Given their high valuations, that is a good question. Should they not be able to meet their targets, they will certainly lose their lofty valuations.

To me, it appears that Facebook's valuation is still a bit lofty, despite the fall from the IPO price of $38. It has the highest price to sales ratio, and a very high price to earnings ratio as well. My advice here is that you short it on the next pop, and we can come back to the name as it goes lower. To me, Facebook's valuation is socially unacceptable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.