Facebook IPO

1st February 2012

Its stock market debut, reports say, will be a bonanza for the company's employees and the investment banks selling the shares – and it dwarfs Google's $1.9bn IPO in 2004. But what about individual investors?

Headlines shout: "Let's get the party started!"; "Facebookers fight for slice of social network's float!" But are the bulls right? Or does the hype lack substance? As the scene builds for flotation between April and June, savvy investors will be asking themselves these questions as Facebook is reported to be filing for its long-awaited IPO as early as Wednesday, says TechCrunch blog.

What can investors learn from history?

Turn back to January 2000. This marks the top of the Internet and technology bubble, when stocks were selling at P/E ratios of 400, or infinity if they didn't have any earnings, says Forbes. That's when AOL bought the biggest media company in the world, Time Warner – a spectacular media marriage failure.

Bert Dohman of Forbes stresses: "Now we have another Web site "distributing" stock to the public. It's a Web site. The profits are not significant given the valuation. Nor apparently is there a plan to monetize its 800 million "members." These members pay nothing to join, and pay nothing to belong."

However, Facebook is profitable. It sells advertisements directed users, and eMarketer estimates that between 2009 and 2011, Facebook's revenues grew at a 127% annual rate to $3.8 billion in 2011, according to the Wall Street Journal, with operating profit of $1.5 billion, adds BusinessInsider.

But it's grossly over-valued

Fundamentally, Facebook has ‘revenues', not profits. So how much is it really worth? As CityAm explains: "To find the answer, you would normally try to value the company using traditional multiples – price to sales, price to earnings and so on – and you would quickly find out that the valuations being discussed look ridiculously rich."

Taking $3.8bn of revenues in 2011 and a valuation of, say, $90bn, that would put it on a price-to-sales ratio of 24 times – or more than any other tech firm out there.  

How about cash flow? At $100 billion valuation, the company's valuation of price/cash flow is eight times more expensive than Apple (AAPL) – and Apple has almost $100 billion of cash in the bank.

So what is the wise move for investors?

While the vast majority of the companies that floated during the initial dot com bubble have fallen by the wayside, those who survived – Amazon, for example, and Google – have thrived. And Facebook has the potential to do the same, but tread cautiously to avoid the ‘hype-cycle', warn experts.

Ian Warmerdam, manager of Henderson's Global Technology Fund, says: "While Facebook is generating a lot of excitement and hype it remains impossible for us to form an investment opinion.

"This is not because we don't believe in the strength of the trend towards social media (we very much do) or that we don't believe in Facebook's competitive position (clearly dominant with a strong competitive moat).

"The spectacular hype surrounding the extraordinary proliferation of Facebook makes exciting headlines but it's only when the more prosaic aspects of P&L and Balance Sheet analysis are able to be properly considered in relation to market value that any genuine investment decision be made. And we have only vague details of these at best."

Beware of the fantasy profits

Wamerdam continues: "As exciting a growth prospect as Facebook presents, we are likely to be wary. The level of hype surrounding social media in general and Facebook in particular is so high that an attractive entry point (from a valuation point of view) may not be achievable.

"As we have seen so often through the history of technology a ‘hype-cycle' tends to envelop new and exciting technology developments. We only need to cast our minds back a short time in history to remember the stock market excitement that surrounded the rise of the Internet,  Nano Technology and Solar Technology to name but a few. These are all genuine long-term growth markets, but were each subject to periods of hype which destroyed returns for unwary investors.

"Analysis of this ‘hype cycle' is an embedded part of our process in the technology team, and we prefer to become involved at a later stage – when the hype has passed, strong growth prospects remain and valuations have become attractive. As strong believers in the social media trend we would love to have an investment in Facebook – but only at the right price."

The Facebook IPO is often compared to that of Google, whose price has risen substantially since its 2004 IPO – from $84 to $580. That amounts to 30% compound annual growth, but bear in mind that Google trades 19% below its 2007 peak of $715.

Ken Eisold, an internationally respected authority on the psychodynamics of organisations, and Mindful Money blogger, warns: "The over-valuation of an IPO is a collusion with the public – as they hope for a windfall and are excited about this prospect, and discount caution in the process. Investors believe they will catch the share price at the right moment and jump out at the right time too, but they are generally wrong – and fantasy fuels this belief."

 

More on Mindful Money

Apple storms ahead – but is it unstoppable?

Are global corporations a safer bet than governments?

What can investors learn from innovative failures?

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24 thoughts on “Facebook IPO”

  1. Anonymous says:

    Hi Shaun

    Did tax reductions have no counterbalancing effect?

    1. Anonymous says:

      Hi Shire

      In the main report taxes only got one mention which covers the latest quarter covered (1st Quarter of 2012).

      “Without taking account of inflation, the quarterly growth of household actual income was 0.2 percent in the first quarter of 2012, the same level of growth seen in the previous quarter. In the latestquarter the main drivers of growth were increased payments of social benefits (contributing 0.6per cent to the overall growth), and lower levels of taxes and social contributions (contributing 0.6per cent). Relatively small growth in wages and salaries meant that it only contributed 0.1 per centto the overall growth. This growth was offset by falling sole trader income and housing services(contributing -0.6 per cent), and capital income (contributing -0.4 per cent).”

      So yes they did help.

  2. JW says:

    Hi Shaun
    If I may concentrate on your last comment. Clearly most people in the UK were not badly off in 2005 or 2003. However we are probably less than half way to where we are going. Also there is the question of personal debt and the consequences of the change of mindset from perpetual improving net income to perceived reducing net income. A ‘2003 person’ derisking and deleveraging is not such a happy bunny. 

    1. Anonymous says:

      Hi JW

      Agreed. What I was driving at was a counterpoint to the regular media “end of the world” stories when in fact when we were last there we thought we were doing okay at the time. This then goes to the next question which is what has changed and I think that we can learn a lot from asking that.

  3. Patrick, London says:

    You have to wonder whether they’re sat there thinking: “You know what… QE and IR reduction haven’t worked out to well… …so… anybody know what the opposite of QE is?”

    1. Drf says:

       Hi Patrick,

      I fear that they have no concern that huge doses of QE debasement and the continued “Emergency” artificially low base rate have not worked to stimulate the economy.  I think the truth is that they know it will not work.  The only reason they persist with these inane policies is to save the insolvent UK government (which will not cut its spending, but rather continuously increases it) and to save potentially insolvent banks.  I also believe that most of the weight for these policies has been forced on the MPC by the Chancellor.

      1. DaveS says:

        Agreed on the reasons for QE but think the MPC can quite happily share the blame with the Chancellor. Some MPC members are well known for demand stimulus (Krugman) view. I think the MPC or rather the BoE has banks as its #1 priority – and seems quite content for bankers to pick up free bonuses from the free money they are throwing at them.

    2. Anonymous says:

      Hi Patrick

      I doubt it, or they would have accepted my application……

  4. Anteos says:

    Hi Shaun

    Debtors have had three years of ZIRP to aid them, and still the economy is in recession and still debt is rising. Reducing rates is not the answer. 

    Its time to kitchen sink houseprices with a rate rise. Lower houseprices will allow FTB’s more disposable income to spend in the wider economy. Better returns on savings will encourage savers to start spending. Its savers not debtors who will get the economy out of recession.

    but this will never happen. The profligate will continue to be bailed out, and inflation ravaged savings, falling annuities will be the price we pay. But Merv and his crew won’t mind with their RPI index linked pensions.

    1. DaveS says:

      If the FTB’s are unemployed they won’t have disposable income. Or if the mortgage rates are 10% the FTB’s wont have disposable income. If the economy is in meltdown I suspect the savers will hang on to their money.

      The trouble is our distorted economy has produced the majority of jobs either in service industries benefiting from housing wealth, or from govt spending financed by housing bubble related tax, or in financial services selling housing products, or directly in housing jobs e.g. plumbers kitchen fitters, surveyors, estate agents – you name it.A house price crash would wipe away a chunk of GDP, a depression perhaps and would risk an upward spiral in Gilt yields which in turn would raise mortgage rates higher than you might have planned.In the very long term, I agree with you – I’m a saver, I don’t have a mortgage. But its a heck of a risk to take and I agree nobody in power would ever vote for it.

    2. Anonymous says:

      Hi Anteos

      Yes too big to fail, ZIRP and QE are failing everywhere they have been used. We are running into a scenario which I have feared from the beginning which is that they do so and we are left with the consequences of them.

  5. DaveS says:

    Its damned if you do, damned if you don’t.

    QE isn’t working – its illogical to expect real GDP growth with falling real-incomes unless you factor in magical export growth – and that isn’t happening – can’t happen given our tiny manufacturing base (please nobody mention our export success with folding bicycles). More QE pumps inflation, puts pressure on real incomes, consumer spending drops, real growth slows or stops, the deficit grows, we need more QE to monetise it – a vicious circle.

    But take away QE, bond yields will climb, possibly dramatically – what is the market rate for a 10 year bond with a country running big deficits and experiencing inflation ? Once the market exits the long gilt trade who knows where it will stop. We get rising deficit due to interest payments – we get what looks like unsustainable debt – bye bye AAA. We get much higher mortgage rates, we get a housing market collapse which will really dampen consumer spending and probably bankrupt a lot of UK banks. We get increased deficits and increased national debt from nationalised banks which will force higher bond yields and so on – a vicious circle.

    So just to be clear – I would vote to end QE tomorrow – it will lead us to disaster. We need a crash, a depression even to reset this crazy economy so in future it isn’t based on ponzi property speculation.

    But I can’t see any central bank or any elected PM/Chancellor ever opting to do the right thing. Its suicide for them. The bankers (who Mervyn represents) and the central London wealthy are doing very nicely from QE. The middle class are moaning now but they will be rioting if mortgage rates go up to 10% and they lose their houses. No party would survive the repercussions and whoever replaced them (eg Ed) would just turn the taps on again. The economic mantra is growth – it doesn’t matter how we get it – except it does.

    1. Anonymous says:

      Hi Dave
      A feature of the current situation is that so many seem to think that the current low level of government bond yields will be a permanent feature of economic life in the US UK et al. It ignores for a start the countries such as Italy and Spain that from not dissimilar (sometimes better) bond yields than ours only 2/3 years ago have seen the reverse.

      To my mind a rising bond yields are a potential danger and we should treat the current situation as temporary. A happy window of opportunity but not a permanent feature.

      1. DaveS says:

        Hi Shaun

        I feel that the single biggest influence on bond yields in UK is the willingness of BoE to buy. Problem for Spain/Italy is that ECB has its hands partly tied and can only buy via the back door – not enough to push yields down and convince the markets.

        Of course if the BoE stops buying then I agree Gilt yields could change dramatically – I wouldn’t be surprised if it ended in a Gilt crisis similar to what Spain/Greece are experiencing. This would be very serious for UK – given the public and private debt burden – probably unsustainable with high risk of a house price crash that would put us in a deficit/debt spiral.

        I feel the BoE can’t ever let this happen – thats the problem with QE – once you start, its very hard to stop. In a sense they would undo all their “good” work to date. I think it more likely that our lost decade will be lost decades and that QE will be a permanent feature of monetary policy in UK – like it is in Japan.

  6. Robert S says:

    Shaun,

    Again, thank you for your continued excellent analysis.

    First, an observation: I was stunned to learn in this BBC (http://tinyurl.com/co6b3wp) article, that the BoE have currently pumped a fifth of our GDP into the economy, and still no sign of life.  And secondly, I was wondering if you’ve written an article on how Mario Draghi can do what ever it takes to preserve the Euro?  Again, in the above article, it talks about a possible theory, and would be interested in your thoughts.

    Thanks very much.

    Robert

  7. Andy Zarse says:

    Hi Shaun, regarding your invitation to Step Back in Time, well never mind stepping, I would strongly suggest You Might as well Jump!  As far as the purchasing power of money is concerned it would be a disaster if we had to go back to say 2003.

    If we are to have 2003 levels of income it would be nice to have 2003 prices to go with them. Back then, petrol was 79pence per litre, and household gas about half too. I paid about 30 pence per litre for household oil back then, I paid 68 pence in March this year. 

    Oh and by the way, I know you like reports from the frontline, well I filled up for Eu1.89 per litre in Rotterdam last week, that’s about £1.47. It was a 600 mile round trip in an estate car doing 30mpg… Ouch!!

    1. Anonymous says:

      Hi Andy

      I do indeed like those reports. The garage around the corner from me is charging £1.39 for diesel now and £1.33 for petrol. So we are cheaper than the Netherlands. I would love to say that we have reduced our prices but suspect it has a lot to do with the improvement in the £ versus the Euro.

  8. Ian_jones says:

    Rational expectations, who’d have thought the theory needed retesting! QE simply shifts wealth around but it is being shifted from income earners to the owners of fixed assets i.e the poor to the rich. The irony of Labour having started the policy!
    Its interesting to read mainstream economists demanding higher nominal inflation to bring down unemployment! It would appear the lessons of the 70’s were not learnt!

  9. Anonymous says:

    Dear Shaun, As I suggested many moons ago and you have implied many times before, the UK has now matched Japan in stagnation and spiraling government debt with no obvious exit. This is ironic given that ZIRP, inflation and QE were designed precisely to stop this happening.
     There are telling differences. Thanks to a positive real interest rate, deflation, zero population growth and a rising exchange rate, Japanese real incomes are still edging up. Even there, however, public finances make this unsustainable.   In both cases, the underlying issue is not macroeconomic. Japan relied on manufactured exports that can now be made cheaper in China, the US or even the eurozone and it simply has not developed replacement new industries (apart from computer games), partly because of the language problem. The UK relied almost solely on the financial sector for growth at the expense of a precipitous decline in most other UK corporates and no longer has the base to renew itself. A measure of this disaster is that UK GDP s now more than 10 per cent lower than France’s, even though the UK now has many more people and France has the euro to cope with. So long as we keep yanking short-term macroeconomic levers instead of tackling the long-term industrial/corporate issues, the UK will continue to lag/fall behind. 

    1. DaveS says:

      Very interesting observations – thanks

    2. Anonymous says:

      Hi Outsider

      I feel that the way out is to reform the banking system. I remember back in the day being told the Japanese one was ok at 24k for the Nikkei 225 followed by 22k,20k,18k,16k,14k etc. It is now 8600 or so.

      I do not believe that Uk banks are solvent and that we are being drip fed bad news. For example wasnt the provision made by Lloyds last year for PPI supposed to be final? Guess what we got this year…So as I have argued before rather than grand twiddling of knobs such as QE or interest rates we need to get involved in a dirty business which is the balance sheets of our banks. Then we know what we need to do otherwise this interregnum will go on and on.

      1. Anonymous says:

        Hi Shaun,
        For once I disagree. The reform plan you outline last September is not practical for a single country to implement in a global industry. The long period of uncertainty would cause a further lending hiatus and ultimately the loss of our great banks which (pause for sick laughter) are one of our last remaining world-beating industries.

        In any case, I am not sure that is really the problem. More lack of loan demand and good lending opportunities. For instance The Co-operative Bank, which has a pretty simple mortgage and small business loan model and is in no sense mired with complex own-account trading,  still saw its loan book fall by 4 per cent last year, causing a big rise in its cash holdings and an 8.6 per cent fall in its loans to deposit ratio.

        Anecdotally, Hammerson has just cancelled the City’s biggest approved office development on the grounds, as far as I can tell, that it might be hard to find profitable tenants, rather than any financing issue. This week, the boss of EDF, the French state-controlled power company, said it was not giving up its planned UK power station programme but was pausing, in order to reduce its stake by bringing in more outside investors (whose cost of capital would presumably be higher than EDF’s). And new home buyers are hardly likely to rush into the market when they are told that house prices are stuck in a downward trend.

        Because so much of our large-scale productive sector is now foreign owned, we have to attract inward investors for growth. Why should they think it worth ploughing money into the stagnant UK market, except perhaps by takeovers? The ICIs and GECs have all gone and have not been replaced, except by banks. 
           

        1. Patrick, London says:

          How can loaning more money out be the answer, unless it is only given to genuine enterprise? When everything is over-priced, and only affordable through debt for the majority, I can’t see how an increase in lending, either through artificially low interest rates, or relaxed criteria, can be anything more than additional can kicking. Bank reform (separation & accountability), housing market reform(BTL taxation, and limits on foreign investment) and an end to QE and ZIRP.

          In addition: Increase subsidies (or remove taxes) from genuine entrepreneurial job creating endeavour. Increase lower threshold for income tax. Remove index linked pensions from the public sector. 

          Blue sky ideas: Create a separate Capital Gains Tax for inflationary based asset value gains to help limit the scope for further asset bubbles. Link taxation from one sector into investment in the same sector.

  10. Anonymous says:

     Hi Shaun,

    I read that an RBS nationalisation is under discussion. After the Northern Rock fiasco, I’d hope the government would learn and change tack.

    Surely it would be better to offer the RBS shareholders a simple choice – you pay your share of the additional funds needed or accept bankruptcy and total loss on your shares ….

    I seem to remember that you said that RBS unlikely to make a profit for the taxpayers

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