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Facebook IS Overpriced

Is Facebook worth the price?

We’re definitely in a tech bubble again. Tech IPO’s are over priced once again. Just last year I wrote the post Groupon – Back to Crazy Company Valuations, in which I explained how and why Groupon was insanely overpriced. What’s happened since that post? They went public, quickly climbed to the $25 mark and then not even a year later they’re barely trading at $12! That’s a 50% price decrease!

Not only that but their numbers still make no sense. Ignoring their accounting oddities and controversies, the P/E alone would be staggering (assuming they had a profit). For the same market cap you could buy quite a few amazing companies with a lot less risk and the same revenue growth.

But today’s article is about Facebook and not Groupon, so let’s look at their story. Why do I believe they are incredibly overpriced? Firstly, the IPO price was insane. $38? Seriously? That gives them a market cap of about $100 billion dollars! In of itself that’s not a big deal, but when you take into account their revenues and then it’s insane!

The P/E for Facebook is over 100! The last time we saw P/E’s like that was in the dot com boom from about a decade ago.

But ignoring that fact, let’s do a comparative analysis of Amazon to Facebook, since they have about the same market cap, are both in IT, and so on. Facebook has $3.7 billion in revenues. Amazon has $51 billion in revenues. Yes that’s more than 10x the revenues. Both are experiencing similar growth rates. Amazon has about 5x the total profits of Facebook. Both are selling for the same price!

So why would I buy a company that’s at least 10x smaller and making 5x less profits for the same price? Or put another way, if you could by a local little store for $100,000 or one for $1,000,000 that had the same revenues, same growth, etc., which would you buy?

Ignoring that, which means ignoring yet another red flag (which in of itself should be yet another red flag – talk about meta), how stable are Facebook’s revenues? We know that Amazon owns ecommerce. But above that, Amazon is also a leader in cloud services. Many many many many companies (some very large companies) rely on them for managing their IT infrastructures. This isn’t small, it’s a huge deal in the IT world. Personally I believe this is the future of Amazon and where they will grow extremely large and powerful.

Ok but that’s just one competitor, and maybe Amazon is wrongly priced, maybe it’s even under priced itself (or maybe overpriced too, it could be that Facebook is that overpriced – I’m not debating if Amazon is a good deal today, just that compared to Facebook, Amazon is a much better deal). But what about some other companies. Did you know that McDonald’s is cheaper than Facebook! Yes, it’s market cap is $90B. That’s 10% cheaper. It’s not growing anywhere the same rate, but still. Anyone heard of Visa? Yeah, that’s cheaper than Facebook! And it’s a company that continues to grow. And no one has any doubts that it’s profitable with their interest rates and all kinds of fees, etc. For the tech oriented there’s also Intel. Yes it’s a bit more expensive than Facebook, but it’s generating 15x the revenues and almost 10x the profits. And it’s revenues are growing (not at the same rate, but still quite nicely nonetheless).

So basically when you buy Facebook, you’re buying the stock with all of the growth of these companies already built into the stock price. In other words, you’re buying it assuming it will grow to the same size as these companies. It has to grow BIGGER than these companies for you to make any profit because the price already includes these gains! That’s a huge claim!

Of course we all know the stock prices are irrational and the price could go higher based on that irrationality, but trying predict irrationality is a fool’s errand and if you don’t jump out at just the right time, you’ll get severely burned. Not something I want to try my luck at!

I believe that the biggest reason Facebook is getting such a high valuation is because of it’s brand awareness. Almost everyone is familiar with Facebook. There’s even been a movie about it. Many many people use it. The problem is that most people don’t stop to think where and how Facebook makes it’s revenues. In case you don’t know, most of it’s revenues come from ads.

Yes it’s similar to Google and their ads (Adwords), except that Google has a major advantage over Facebook. People on Google are actively searching for something when they go to Google. They aren’t just perusing and maybe they’ll click on an ad, they’re actively searching for something, including the ads! With Facebook, the ads are a distraction. When you use Facebook, it’s to socialize. It’s not to actively look for products. You’re in a completely different mindset. You don’t go to Facebook to find something, you go to socialize. With Google you go to find things.

And since Google and Facebook share such a similar business model, it’s only fair to compare them. Google is priced at twice the price of Facebook ($200 billion market cap). Google’s revenues are growing quite well, similar to Facebook’s. But Google is generating more than 10x the revenues and about 20x the profits!! Not bad for twice the price. And you don’t have to hope it will make it, it’s already there!

So let’s do a comparable analogy of Google and Facebook. If I was to give you two options:

– Buy stock A for $1 that’s generating $0.61 revenues and $0.20 profit
– Buy stock B for $1 that’s generating $0.04 revenues and $0.01 profit

Which would you want to buy? It’s pretty clear and obvious isn’t it? Now let’s say I added another:

– Buy stock A for $1 that’s generating $0.61 revenues and $0.20 profit
– Buy stock B for $1 that’s generating $0.04 revenues and $0.01 profit
– Buy stock C for $1 that’s generating $0.52 revenues and $0.05 profit

In case you’re wondering, stock C is Amazon. In either case, as you can quickly see, Facebook is incredibly overpriced. At this time, Google would appear to be the best deal (best profits – and a higher profit margins!). Of course this quick analysis is missing a lot of factors such as growth, marketspace, etc. But it’s good enough to see the scale of the valuations of the different companies. Kinda makes you think doesn’t it?

So how is Facebook fairing since the IPO? Well firstly did you know that Morgan Stanley spent billions to support the initial IPO price point?. Yes the market wouldn’t bare the initial price so it had to be propped up.

And since then, the price has continued to decline. Right now as I write this the price is hovering around $31/share. That’s approximately a 18% price decline in just a few days! And the biggest tell of the stocks success will be when it releases it’s first real financial report as a public company. If it doesn’t meet the incredibly high expectations, well let’s just say the market has a history of not being too kind to such stocks. It will be interesting to see how Facebook does on its first filing after the IPO.

But do remember that for Google, as important as the big accounts are, Google Adwords has a lot of small accounts too. My company LandlordMax spends quite a bit on Google Adwords advertising each month. And we will continue to do as long as the ROI is positive. However many small businesses aren’t experiencing the same positive results on Facebook. Here’s just a few examples:

As you will quickly notice, the results weren’t just not positive, they were atrociously negative. As in extremely bad! To the point that it’s in not even worth trying to adjust and fix.We’re not just talking small companies with naive marketers, but we’re also talking large companies with large budgets. That’s why I can’t see the same expenditure levels on marketing for Facebook ad campaigns as are happening today with Google Adwords. Yet this growth is already assumed and calculated into the current stock price.

Again some people have shown success, but I have read too many similar articles like those above to dismiss them as just bad luck. Sure Google has similar unsuccessful stories, but they are rare in comparison.

Being an entrepreneur, I constantly talk to a lot of other fellow entrepreneurs, and I have yet to personally meet someone who has had a successful Facebook ad campaign. Again, some people obviously have had success, and you can find articles about it. I just don’t personally know any. Whereas with Google Adwords I know of many people actively using it with positive ROI, including myself. So as anecdotal as this observation is, it’s still an important observation for me. Firsthand experience down in the trenches is always very valuable and should never be dismissed.

But if you buy Facebook stock, then the price includes this growth in today’s price. It has to acquire all these customers and more to justify it’s current price! Any increase in market cap (stock price) is then based on further expected growth and not actual real growth. Sure signs of a boom with a very high potential for a large price drop.

And in my personal predication Facebook will NOT meet it’s expectations. Facebook is a cool system, and it’s great for social networking, but in terms of a advertising value for a company I believe it has limited value. Unlike Google where people are actively searching, with Facebook the ads are more like banner ads. And we all know that banner ads have atrocious click through rates, just like Facebook ads are appearing to have. Yes you can significantly improve your targeting, but does that really matter that much? It doesn’t appear to be making that much of a difference in terms of ROI for Facebook ad campaigns from the results we’re seeing. And I can’t see it improving. I also can’t see Facebook trying to compete in search. So I personally don’t understand how they will ever get the same ROI on ads as Google.

Now I’m not saying Facebook isn’t a good business, it definitely is a good business. And it can definitely earn revenues and is profitable. All I’m saying is that the current price of Facebook is not inline with the value of its business. It’s too overpriced. If the price dropped significantly I would probably start to get tempted. But right now, it’s just insanely priced for what you get. Which means the price of the stock only has one direction to go, DOWN! Maybe not today, but give it a 1-3 years and it should better line up with it’s real value.

In either case, we’ll know soon enough. I’ll definitely have to post a follow-up in a year or two to see what happened between my initial predication today and then.

Update: Looks like the Facebook IPO is about to get quite messy!! It appears that the earnings estimates for Facebook were downgraded for the IPO but not everyone was notified. Firstly it’s very odd to do it at the very last minute of an IPO, but what’s even more worrisome is that some bigger investors were notified which is considered insider information. This could get really ugly real quick!!

Update 2: It’s quickly escalating. It now looks like Morgan Stanley, Goldman Sachs, and JP Morgan, along with Facebook itself, are being sued by investors claiming to be misled in the purchase of the Facebook IPO. If you thought Martha being sued for insider information and trading was a big story, this is going to explode in comparison. One of the largest IPO in history, an over-hyped IPO, investors losing 20% in two days, large dollar values of insider trades, a high profile company, it all has the making of one of the biggest stories of the year. I’ll even predict that a movie, even if it’s just made a made for tv movie, along with at least 2-3 books, will be released within a year.



 
Like this article?

Comments:

  •     Justin
    · May 28th, 2012  · 7:01 pm  · Permalink

    You make a compelling case!

    I think I’ve detected a typo – in your 5th paragraph you wrote “Amazon has about 2x the total profits of Facebook.” I think you meant 5x the profits, which is what you seem to indicate in the next sentence and elsewhere in the post. Correct?

    So are you shorting Facebook stock?

  •     followsteph
    · May 29th, 2012  · 7:22 pm  · Permalink

    Hi Justin,

    Yes I did! Thank you for catching that. I just updated the post.

    And I wish I could short it. Too many people are doing just that meaning that there’s very little return now. The bidding is just too competitive.

    One company I’m very seriously considering shorting is Apple with a long term horizon, say 2-5 years. It’s corporate culture is dramatically changing and it’s going the route of every other IT company. Especially that it’s on such a high right now from Steve’s legacy. Once that pipeline dries up, I suspect things will be much drearier for Apple…

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