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It’s officially the year 2000 again.
Facebook, with $2 billion of revenue and $700 million of earnings, is valued by Second Market’s latest share auction at $70 billion. This is a roughly half of Google’s (GOOG) valuation, net of tangible book value, even though Google has $25 billion of revenue, $10 billion of earnings, and higher operating margins than Facebook.
The probability that investors in Facebook will make money over a long term holding period at the current valuation is pretty close to zero, but I could see Facebook’s shares continue to appreciate in the short run. In fact, I could see Facebook being valued at $100 billion or even $150 billion pre-IPO. This will inevitably lead to the mother of all exits after the IPO lock up expires.
People so quickly forget that 10 years ago it was Yahoo! (YHOO) that was going to “own the web”. Yahoo’s market cap 10 years ago, not adjusted for inflation, was about $100 billion. That would be about $150 billion today. Today Yahoo!, net of tangible book value, is being valued by the market at $0. Yes, that’s not a typo. Net of it’s investments and cash, investors currently think Yahoo! is worth nothing. Nada. Zilch. This is even though Yahoo! generates $1 billion in cash flow on $5 billion of revenue. Why? It’s no longer the hot Internet company. It’s yesterday’s news. You can only be the “new, new thing” once and then it’s over.
Facebook investors at these prices are going to learn that very hard lesson unless they can successfully unload their shares to a greater fool before the music stops.
Just in case you’re looking for a company even more overvalued than Facebook, check out Groupon. Unlike Facebook, which does have a tremendously valuable network, technology, and scalable business model with low fixed costs, Groupon has none of that.
Groupon is nothing more than the modern version of a coupon book that is online instead of showing up in your mailbox as junk mail.
Groupon has achieved tremendous growth in a short period of time, but to do that they needed to hire thousands of salespeople. Groupon is hiring hundreds of new salespeople every month to keep growing. This is not a scalable business model. They have already saturated the market. They have no network effect or proprietary technology. Yet they’re planning a $17 billion IPO.
I almost feel sorry for the investors who will buy stock in their IPO thinking it is anything other than a chance for the founders, employees, and early investors to cash out, bankers to earn huge fees, and market makers to profit from selling options and shorting the stock. The reason I don’t really feel sorry for the investors is that anybody who does simple math and knows economics 101 would know better than to think Groupon is worth anything close to $17 billion.
The people buying their stock fall into the category of people who are too greedy for their own good. They believe a greater fool will buy their stock for even more money, and in the short run they may be right. In a bubble, anything is possible. Who’s to say Groupon won’t at some point be worth $100 billion? It could be, but not for long.
The long term value of this business is dramatically lower than even the $6 billion Google was willing to pay. There are no barriers to entry. Over time, every big company on the web, including Google (GOOG), Microsoft (MSFT), Amazon (AMZN), Facebook, Twitter, et al will be doing the same thing. Margins will compress. Profitability will decline. Revenue will stall or even decline. These outcomes are about as guaranteed as anything in the economic universe. The only question is how soon.
On top of the competitive problem, Groupon faces the problem of its business model itself being more of a fad and unsustainable. The fact is that most businesses who use Groupon have complained that they lost money on the deal and it didn’t help their business in the long run. How can you keep growing your business with all this negative word of mouth from your customers? The answer is by hiring hundreds of salespeople every month to find new customers. How long can this game continue? Not for too much longer.
Until then, everybody at these companies can keep partying like they did 10 years ago. In this economy, who wouldn’t be nostalgic for the good old days when 22-year-old kids making millions was common and the unemployment rate was 4 percent? Today it’s more common for people to still live with their parents and not have a job at 26 and the unemployment rate is either 9.5 percent or 20 percent depending on which version of unemployment you follow.
Maybe part of the enthusiasm for Facebook and Groupon is really about hope. Hoping that if we can just pretend the past 10 years haven’t been a disaster but just a bad dream that all the misery will just go away. Hoping that we can go back to that perfect economy of 10 years ago. Maybe all we really have left after 10 years of economic decline is hope. That is a sad story, but maybe it’s true.