May 31, 2012 at 14:12 PM EDT
Why Facebook’s IPO Valuation is Insane
I was recently on CNBC discussing the Facebook valuation, which I believe is priced for out-of-this-world perfection. The easiest way to assess the insanity of Facebook’s valuation is by comparing it to Google’s. Facebook is set to go public at a sweet valuation of $100 billion, and it has estimated revenue for 2012 of about [...]

I was recently on CNBC discussing the Facebook valuation, which I believe is priced for out-of-this-world perfection. The easiest way to assess the insanity of Facebook’s valuation is by comparing it to Google’s. Facebook is set to go public at a sweet valuation of $100 billion, and it has estimated revenue for 2012 of about $4 billion.

However, investors are not buying Facebook today because they believe it is fairly valued, so what is the point of the comparison? Bear with me for a moment. Let’s say Facebook investors want to receive 15 percent a year over the next five years. In that case, Facebook’s market capitalization has to double in five years, to $200 billion. Conveniently, $200 billion happens to be Google’s valuation today. Since both companies are in the advertising business and have very similar cost structures, all Facebook has to do over the next five years is achieve Google’s current sales level, which is a meager $40 billion (for purposes of this discussion, we’ll ignore Google’s $40 billion pile of cash, or about $100 a share, compared with Facebook’s few billion, though that would only further make my point here). For an investor to double his or her money over the next five years, all Facebook has to do is increase its revenues tenfold.

That sounds doable at first glance. When your name defines what social networking means, and when you have 900 million users, nothing seems unconquerable. Still, increasing revenues tenfold may become a difficult undertaking for Facebook. First of all, there is a user fatigue. I find that as the novelty of Facebook wears off, I spend less and less time logged in to my page. (Interestingly, I find that I use Twitter more and more every day, because I strictly use it as part of my research process).  One can argue that it may just be me, but a study undertaken by a web research company last fall shows that users are indeed getting Facebook fatigue. In addition, Facebook is a productivity drain, and employers will likely start blocking employee access to Facebook during business hours, which will further decrease the time spent on it.

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Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

 

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

 

 

 

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