Is Facebook (Nasdaq: FB) a Replay of the AOL/Time Warner Deal?Companies / Tech Stocks May 24, 2012 - 07:26 AM GMT
Martin Hutchinson writes: I hope you didn't buy shares of Facebook (Nasdaq: FB). The valuation was always too aggressive.
And increasing both the price and amount of Facebook stock at the last moment ensured that both underwriters and retail investors ended up with far more shares than they bargained for.
In fact, the Facebook fiasco reminds me of another deal that marked the peak of the dot-com boom.
No, not the ineffable and rather sweet Pets.com- their IPO was far too small a deal to have genuine market significance.
Instead I'm talking about the AOL and Time Warner merger announced on January 10, 2000.
Like Facebook, the deal was sold as a big success. It was only later that it quickly became clear that AOL had sold itself at the absolute peak of the market.
From there on out it was all downhill as the storied merger practically top-ticked the market.
Before Facebook There Was AOL
AOL had built up a nice business from "dial-up" Internet access, but it was already obvious by January 2000 that the arrival of broadband Internet would make for a difficult transition.
As such, AOL's market capitalization of around $200 billion was purely the result of the frothy market of 1999.
Nevertheless, that rich valuation enabled AOL to become the senior partner in an acquisition of the Time Warner media conglomerate, getting 55% of the merged company in a deal valued at $350 billion. It was the largest merger in U.S. history.
At the time there was a great deal of talk about how the Internet had revolutionized life to such an extent that AOL's Internet access and modest content businesses would provide immense synergy to Time Warner's magazine, cable TV, film and broadcasting assets.
In reality, the deal was a disaster for Time Warner.
In the aftermath, Time Warner reported a loss of $99 billion in 2002 because of AOL-related write-offs, Steve Case resigned as chairman in January 2003, and AOL was spun off again in 2009.
Time Warner's market capitalization fell from $350 billion to below $20 billion in the ensuing downturn. It is only $33 billion today.
In short, the AOL/Time Warner merger marked the peak of the dot-com bubble. The Nasdaq Composite index peaked at 5,048.62 two months later and has only recently risen above half that value.
The ability of AOL to be valued at more than the giant Time Warner came to be seen as an anomaly, and the difficulties experienced by the deal helped to puncture market euphoria.
Subsequent deals valuing Internet companies at bubble prices proved difficult or impossible to get done. The market began to slide from the spring on, with confidence finally ebbing away in the contentious 2000 election aftermath.
Facebook (Nasdaq: FB) is AOL Revisited
To me, the Facebook IPO looks very much like the AOL of 2000.
Its growth is already slowing, with first-quarter revenue down on the fourth quarter. Unlike Google (Nasdaq: GOOG) or Apple (Nasdaq: AAPL), it does not seem an essential part of the Internet scene.
Indeed even in Facebook's business sector, LinkedIn (NYSE: LNKD), the business connections social network with a market capitalization of $10 billion, has a more well-defined economic purpose.
Like AOL, Facebook's valuation was pushed beyond its natural limit, partly because the company had large numbers of well-connected shareholders who wished to exit at the maximum possible price.
The issue was too large, the issue price was set too high, and the Nasdaq trading glitch prevented the stock from getting the initial "pop" that might have convinced foolish retail investors that it was too good to miss.
The company has around $10 billion in cash, so it isn't worthless, but I would have a hard time assigning it a value of much above $15 billion-say $5 or $6.
Falling to $31 in its first trading days, Facebook is making good progress towards that modest goal.
If it falls below $19 or so before Goldman Sachs' private equity clients can get out, I shall smile with relief. There was altogether too much of an insider ramp by the well-connected at $19/share followed by a sale to suckers at $38 within a year or so.
Like the AOL/Time Warner merger, the Facebook IPO has messed up the market for the rest of the tech sector as a whole and social network companies in particular.
The underwriters were left with a lot of stock, and were chiseled down on commissions, so they won't be anxious to repeat the process.
Companies with massive private equity followings will find an unenthusiastic reception in the public markets, as investors will suspect that, like Facebook, they were gigantic "pump and dump" operations.
If Goldman's buddies lose money on Facebook, the appetite for late-stage private equity investment will be curtailed -- no bad thing as it is too often used as a substitute for a proper IPO to the general public.
Valuations, in any case, look likely to decline. To that extent the "social network" bubble will have burst, and probably the second Internet bubble also.
In the long run, the economy will benefit from this as resources are reallocated to more useful sectors; in the short run the process will inevitably be painful.
As investors, we might want to look at weeding our tech portfolio, however good our investments' long-term prospects may appear.
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