The $100 Billion Question: Is It Worth It?

facebook craps table

Weekly Market Commentary 5-7-12

Even before February 1st when Facebook filed with the SEC to go public, investors have wanted to get their hands on Facebook. It now appears that investors will get the opportunity on May 18th. We normally don’t highlight specific companies or IPOs; however, given that this will be the largest American tech IPO, and it’s a company almost everyone is familiar with from a user standpoint, we wanted to discuss the company from an investor standpoint.

Valuation: High

This is arguably the most anticipated tech IPO since Google, and that means if you want in on May 18th, you’re going to have to pay up. It doesn’t matter what valuation metric you use though; they all point to a very high valuation. Two popular valuation metrics are the price to earnings ratio (P/E ), and price to sales ratio (P/S). Facebook has a P/E of 99 and a P/S of 24.

Compared to other tech giants these ratios are pretty high:

company PE and PS for tech companies

Google is probably Facebook’s biggest competitor for online advertising revenue dollars and their valuation metrics are much more in line with traditional valuation levels. Apple is also a tech company that most investors are familiar with and is currently experiencing record growth. Last quarter Apple blew away earnings estimates with 94% growth in earnings yet still trades at a much more reasonable valuation.

Slowing Ad Revenue

If you’re a user, then you know it’s free to create an account on Facebook and you’ve probably seen the ads on the side of the website. These ads are where Facebook makes a majority of its revenues. It sells ad space on its website to other businesses that are targeted to you based on the information you filled out on your profile and things you “like”. In theory, the more information you provide, and the more active users, the more valuable Facebook becomes.

At the end of April, Facebook released its financial performance for last quarter and it was a surprise to most Wall Street analysts:

facebook quarter to quarter growth

Facebook attributed this decline to seasonal advertising trends but no matter how you slice it, the growth isn’t what most Wall Street analysts were expecting.

IPO Price versus Actual Price

Facebook officially announced they anticipate the initial public offering price will be between $28 and $35 per share. Most investors unfortunately will likely be paying much more to get their hands on shares of Facebook on May 18th.

This price range represents the range in which Facebook will be selling shares to large institutional investors and other top clients of the investment banks. This is the actual initial public offering and this usually takes place the day before they are listed on the exchange.

Once they are listed on the exchange the following day, the shares are then traded among other investors in the secondary market. Most investors will have to buy shares in the secondary market where prices are dictated by market forces such as supply and demand, not Facebook.

For example, the same thing happened last year with LinkedIn’s IPO. The day before it was listed, LinkedIn and the investment banks sold shares to institutions and top clients at $45 a share. However, the following day when you and I could buy them on the secondary market the price was anywhere between $80 and $120 a share! Double, almost triple the so called, “IPO price.” Since demand to own a piece of Facebook appears pretty high, I think it would be highly unlikely for most investors to get shares at the “IPO price.”

Some investors will buy Facebook no matter what, updating their Facebook statuses on May 18th as proud shareholders of Facebook. However, if you look at it from an investor standpoint, you might be buying in at an intermediate term high.

If you have questions or comments please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can Email me directly.

Adam Gulledge, Associate – Phillips & Company