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Fuzzy Math, Greater Fools and the Facebook IPO

Companies / Tech Stocks Feb 10, 2012 - 06:39 AM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: I have several friends who think the Facebook IPO is the next Microsoft.

I think it's more likely the next Research in Motion.

Or perhaps the next Sony, Kodak, or Eastern Airlines--all of which were once world-class brands that got sideswiped by hungry new competitors.


Facebook...you may as well buy a lottery ticket.

Don't get me wrong. In just a few short years, Facebook has accumulated an unprecedented 845 million users representing 12.07% of the world's population.

But does that merit an offering worth as much as $100 billion?

Maybe to a lot of people, but not to me.

Think about the numbers.

There are 7 billion people on the planet today, 5.15 billion of whom live on $10 or less a day. Of that group, roughly 3 billion people live on less than $2.50 a day.

That means if you remove those who live on less than $10 a day because theoretically they can't afford a computer or don't have enough disposable income to be monetized, that leaves roughly 1.85 billion potential Facebook users.

In a perfect world where a company could capture 100% of its target market, that would cap Facebook's potential user growth at 118.93%.

But we don't live in perfect world. As far as I know, no company has ever captured 100% of its target market. Not once.

There are always those who drop off, leave or simply don't buy no matter what the product is or how good the "offer."

That's not to say it couldn't happen, but unless Team Zuckerberg figures out new ways to monetize users or invents an entirely new class of customers, there is relatively little upside remaining in terms of the company's target market.

The Fuzzy Math Behind Facebook
And another thing, in my best Andy Rooney voice, according to Yahoo Finance, Microsoft's adjusted close on March 13, 1986 was $0.08. As of January 30, 2012, the stock was trading at $29.61, which means Microsoft stock has delivered a mouthwatering 36,913% return over the last 26 years.

For Facebook to deliver similar returns at its proposed $100 billion valuation, Facebook's market cap would have to increase to $36.21 trillion. That's roughly 57.47% of the entire world's GDP.

Possible? Sure. But there's a big difference between that and what's probable.

If Facebook is really worth $100 billion, that means the company would come out of the gate at roughly 27 times 2011 sales and nearly 100 times 2011 earnings. By comparison, Google trades at 5.22 times sales and carries a P/E ratio of 20.42 times earnings.

In other words, you'll have to wait 100 years to justify your Facebook investment versus a mere 20.42 years for Google. Dividends would obviously bring that figure down in a hurry, but to my knowledge the company has no such plans.

Google went public in 2004, raising $1.9 billion against a valuation of $23 billion - a record for the largest U.S. Internet IPO that has stood until now. At the time that worked out to 10 times sales, or less than half of Facebook's proposed initial valuation.

Even Apple, by a far more dynamic company backed by real products, trades at only 3.38 times sales. That's less than 20% of the estimates for Facebook's projected price to sales ratio. And Apple has a market cap of $460 billion.

Facebook's Greater Fools
At the end of the day, I realize that nothing I say can change your mind if you've decided to take the plunge, so I'll wrap up with one final thought.

Investors who fancy tech stocks often argue that the future matters more than current valuations, no matter how absurd they might be. That's why stocks like Facebook are "worth" the risk.

I have no comeback to that. I can't argue with how a technology might be used 10 years from now.

But I can point out that companies like Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG), and Microsoft (Nasdaq: MSFT) are fairly valued based on current earnings, cash flow and their respective cash stockpiles.

In other words, their stock prices reflect stuff that could realistically have a material effect on how each of these companies grows within the next 12 months - or not.

So where does that leave us?

If you're a day trader and you have money to burn, Facebook may make a superb opportunity. I think it could easily double on nothing more than the greater fool theory.

You know the one...that's where you plunk your money down on nothing more than a wing and a prayer (because you don't have earnings, sales or real products to back up your chosen investment).

And you hope a greater fool comes along at some point in the future willing to pay you more money than you spent to buy the stock in the first place. Just remember -- you're the greater fool who bought it in the first place.

But if you're an investor, I'd wait a year.

Let Facebook go public and bleed out the hype. Give it some time to build a public track record. Then, using that data, make a market-based determination as to whether or not you want to invest.

Of course, I suppose you could always break out the Magic 8-ball, too.

Just make sure you shake it hard enough to avoid another case of "MySpace."

Source http://moneymorning.com/2012/02/10/fuzzy-math-greater-fools-and-facebook-ipo/

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