Facebook IPO: The Sound of Bubbles Popping

by L J Furman, MBA on May 21, 2012

in Finance, Value Investing

Soap Bubble

Soap Bubble, by Irfan Mirza

 Facebook went public on Friday, May 18, 2012. Trading for FB opened at $42.025 per share, giving the company a market capitalization of $72.76 Billion. However, Facebook closed it’s first day as a publicly traded stock down 9.3% at $38.105 per share. On it’s second day, Monday, May 21, it opened at $36.53 per share and closed at $34.03 per share, dropping another 6.8%, and 19% from the opening price. It’s sliding is raising eyebrows in the financial media (Business Week, Chicago Tribune, Reuters).

A Bubble Popping, by Richard Heeks

Bubble Pop, by Richard Heeks

But the question may be less “Why is Facebook’s stock price dropping?” or “Who’s to blame?” than “What should be it’s price?

GMO‘s Jeremy Grantham talks about “Reversion to the Mean.” The mean, however, for a stock with 2 days of history is not statistically meaningful. So I compared it to Apple, Google, IBM, Microsoft, and Oracle, pulling data off of the Internet at Finance.Google.Com after the close of trading on Monday, May 21, 2012.

(Image Links: Soap Bubble & Bubble Pop)

I looked at the two key financial ratios: Debt to Asset and Net Profit Margin. In terms of Profit Margin, Facebook, is roughly equivalent to Apple, Google, and Oracle. It is higher than IBM and lower then Microsoft. Facebook’s Debt to Asset ratio is about the same as Microsoft’s. It’s lower then IBM’s and Oracle’s, higher than Google’s. Apple has no debt, it’s Debt to Asset ratio is zero. This is described in Table 1, “Financial Ratios.” (Definitions are on “Investopedia.”)

Financial Ratios
Company Debt to Asset Net Profit Margin
FB 10.69 26.95
AAPL 0.00 23.95
GOOG 5.79 25.69
IBM 26.90 14.83
MSFT 10.95 33.10
ORCL 21.65 23.99
Table 1

A reasonable interpretation of these data could be that Facebook is a strong company. It has a huge market, and it makes money. However, this doesn’t mean the stock is a good investment.

FB’s Earnings Per Share is $0.31; meaning the company earns $0.31 per share. It’s P/E ratio, the patio of price of a share to earnings is 108.92. Each share of stock is priced at 108.92 times the money that Facebook earns for that share. In comparison, Google’s P/E is 19: each share of Google is priced at less than 20 times earnings of a share of stock. IBM’s is 15. Oracle and Apple are at 14. Microsoft’s P/E is 11. This is described in Table 2, “EPS & P/E.”

FB 0.31 108.92
AAPL 41.02 13.68
GOOG 32.99 18.61
IBM 13.41 14.74
MSFT 2.75 10.82
ORCL 1.90 13.83
Table 2

Put another way, If Facebook had the same P/E as Apple, 14, each share of Facebook would cost $4.27, not $34. If Apple had the same P/E as Facebook, 108.92, each share of Apple would cost $4,468.90. This is described in Table 3, “Comparative Pricing.”

Comparative Pricing
Company FB at Other’s P/E Other at FB’s P/E
AAPL 4.27 4468.90
GOOG 5.81 3594.24
IBM 4.61 1461.33
MSFT 3.38 299.48
ORCL 4.32 206.81
Table 3

Personally, I think this suggests that Facebook is overvalued. However, the “Business Social Network,” Linked In, LNKD, with Earnings per Share of $0.16 and a stock price of $98.84 per share, has a Price Earnings ratio of 599. Compared to Linked In, Facebook is drastically undervalued.

Table 4 shows the Current Price, 52 Week Range and Market Capitalizations of these companies, including Linked In.

Basic Information
Company Symbol Price at Close, 5/21 Mkt Cap (in Billions) 52wk high 52wk low
Facebook FB 34.03 72.76 45.00 33.00
Apple AAPL 561.28 524.83 644.00 310.50
Google GOOG 614.11 200.22 670.25 473.02
IBM IBM 197.76 228.11 210.69 157.13
Microsoft MSFT 29.75 249.93 32.95 23.65
Oracle ORCL 26.26 130.65 34.60 24.72
LinkedIn LNKD 96.84 10.00 120.63 55.98
Table 4

Facebook has earnings, and something like 1 Billion users. That’s One out of Seven people.  So there is something there. But while there’s something there, zero of those 1,000,000,000 users PAY FaceBook to USE the SERVICE. It’s not the NY Times or NPR. There’s no subscription fee. However I would value Facebook, based on its earnings, between $7.0 and $10 Billion, not $72 Billion. This valuation would consequently price each share somewhere between $3.75 and $6.00, not between $34.00 and $42.00 (unless there’s a 1 for 10 reverse split).

As noted Facebook is not the NY Times or NPR. Facebook is a social network with about 1 Billion members. Facebook’s “News” for each of those 1.0 Billion people is “What are my friends doing?” not “All the News that’s fit to print.Facebook‘s upside would be huge if they figure out how to “monetize” the membership. And even if they don’t figure out how to monetize membership, Facebook’s existential and historical value, in helping midwife the Arab Spring (altho that was more Twitter than Facebook) is tremendous.

Disclosure: I am long on Apple and IBM.

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