Tuesday, November 29, 2011

Facebook's IPO: $ 100 Billion Valuation?

This post from back in June looked at Facebook's potential valuation and compared it to some other large technology businesses.

Is Facebook Worth $ 100 Billion?

It now appears Facebook is getting closer to an IPO with a valuation at or, at least, near that $ 100 billion number. The IPO is expected to happen between April and June of 2012. This Wall Street Journal article points out the company wants to raise $ 10 billion. That would make it rather a large IPO by any standard.

The expected valuation?

$ 100 billion

Wall Street Journal: Facebook Targets Huge IPO

At $ 100 billion, Facebook will have nearly 4x the market valuation that Google (GOOG) had when it went public in 2004.

The Wall Street Journal article also says Facebook expects to have more than $ 4 billion in annual revenue once it goes public.

$ 4 billion revenue already. Facebook may turn out to be a terrific business. Whether it's a good investment is less clear at this point. It certainly will be one of the more interesting IPOs in a while. It's supposed to be profitable already but, for now, we don't have much detail on the financials. That will soon change. This Reuters article from back in September said net income in the 1st half of 2011 was almost $ 500 million (according to an anonymous source).

Previous post: Facebook's 1st Half Revenue Doubles

The SEC will require Facebook to make its financial information public once it has 500 shareholders. It's likely that will happen soon so it's a good bet we'll see more detailed financial information by April of next year.

If the Reuters article is correct, Facebook's annualized earnings should be $ 1 billion plus. Paying $ 100 billion for $ 1 billion plus of earning is obviously a very high multiple yet, considering the growth rate, who knows what the business is worth.

From this Bloomberg article:

"It's obviously a very steep valuation," said Schuster, whose firm invests in IPOs and oversees about $2.5 billion in assets. "They are realizing their window of opportunity, and they want to do it sooner rather than later."

On the surface, at least, Facebook's prospects are impressive. It looks to be potentially one heck of a potential franchise.

It may turn out to be a juggernaut for all I know. In time, it could even become clear why it's worth every penny of that $ 100 billion valuation. Yet, that doesn't necessarily make it a great stock to buy on a risk-adjusted basis.*

Investors don't put money at risk for the privilege of eventually getting their money back. It is about getting the best risk-adjusted return (preferably on something with a future prospects that are easily understood).

Price paid relative to value regulates risk. Higher uncertainty around valuation should logically require a greater discount, more of a margin of safety.

I think it is fair to say that starting at a $ 100 billion valuation takes away plenty of upside while offering quite a bit of downside if some dreams aren't realized.

With the information currently available and a relatively short track record, Facebook is obviously tough to value. We'll get more details and perspective on Facebook as the IPO approaches once the S-1 comes out.

It's worth noting that Apple (AAPL),who's not exactly growing slowly, has the earning capacity of roughly thirty Facebook's, yet an enterprise value (market cap - net cash and investments) that is less than 3x that $ 100 billion valuation.

Most companies when they go public do not start out as a large cap stock but it looks like Facebook's going to be an exception. I mean, quite a few rather solid, if less exciting, established business franchises could be bought for around $ 100 billion.

For example, the $ 100 billion could be used to buy all** shares of PepsiCo (PEP) and there'd still be a billion plus dollars remaining to start a nice venture fund.

Alternatively, that money could buy the three large U.S. railroads (CSX: CSX, Norfolk Southern: NSC, Union Pacific: UNP) not owned by Berkshire Hathaway (BRKa). After taking control of the railroads (and dealing with the inevitable anti-trust issues) that buyer would still have several billion dollars in the bank.

Easily enough pocket change to buy a full year's worth of production by Ferrari, Maserati, Aston Martin, and Lotus (hey, maybe even a Formula 1 team).

At least for me, those cars would be enough compensation for not being able to participate in the excitement of an IPO.

Besides, I'll take railroads over a social network. Even if the upside is more limited, in their current form the future prospects for railroads are easier to figure out and importantly, not too long ago, the price for some of them was right.

Adam

Related posts:
Facebook's 1st Half Revenue Doubles to $ 1.6 Billion
Is Facebook Worth $ 100 Billion?
Technology Stocks

* Near the expected valuation, the risk of negative returns is uncomfortably high if things go a bit less well than expected. Having said that, sustained high return on capital over 2 or 3 decades eventually does make an initially expensive looking investment make sense. In the very long run, results tend to be drawn like a magnet toward the return on capital earned by the business. I don't think I have any capacity to even roughly estimate Facebook's return on capital or its sustainability over such a long time horizon. Others may be able to.
** Of course, in the real world a premium to market value would need to be paid to buy all shares.
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