Did You Invest in Facebook?

Perhaps you did or maybe you elected to take a wait and see approach.  It doesn’t matter as there are lessons to be learned regardless of which group you are in.  You probably lost money if you are in the first group and have sold your shares.  There is a possibility that you may recover all or part of your loss if you can prove that your trades were not executed in accordance with your wishes.   Investigations are likely to go on for some time until we learn how the opening day fiasco will be resolved.  If you are in the second group and remained on the sidelines, you can wait it out and purchase shares on the open market whenever you choose or never purchase shares in Facebook. 

Shares of Facebook were hovering around the $28.00 mark, $10.00 below the offering price when I posted this blog.  Some of you are probably kicking yourself and moaning, “If I only knew, I would have waited”.

What about the lessons referred to above, lessons that may make us smarter investors?  First, it should be recognized that there was a huge amount of anticipation and emotion regarding this IPO.  Most of this stems from the fact that there are in the neighborhood of 900 million Facebook users.  That is a humongous number of users for one social networking platform.  Secondly, we know that Facebook’s primary source of revenue is from advertisers.  I don’t know the number of advertisers on Facebook, but it is safe to say that it is nowhere near 900 million.  In the interest of full disclosure I do not have a Facebook page much to the displeasure of my son and daughter-in-law who have been applying much pressure to get me on the social network.  As part of my fact checking I called my son to ask him several questions about Facebook.  He has been on Facebook for some time and on one occasion took great pride in showing me his farm.  My first question to him was did he have to pay any money for his Facebook page.  His reply was negative and he quickly responded with “If I had to pay do you think I would be on it?”  My next question was whether any of his Facebook activities require him to pay money to Facebook.  He assured me that nothing he does on Facebook requires the payment of money, use of a credit card, etc. 

The 900 million mostly non-paying users do not translate directly into a Facebook revenue stream.  I recognize they can be a great target for advertisers, but we heard shortly before the IPO that General Motors was pulling their $10 million worth of advertising from Facebook due to difficulty measuring the effectiveness of their advertising.  If a sophisticated advertiser like GM could not determine the number of cars sold from advertising on Facebook how will other advertisers measure their advertising effectiveness on this platform?

In my more than 40 years of business experience I learned that successful companies require a sound business model.  In my opinion much of the euphoria over Facebook was not based so much on its business model or its future earnings prospects, but was attributable to the 900 million Facebook users.  I also have experience in valuing businesses and have given expert witness testimony on this subject.  Shortly before the Facebook IPO I was listening to analysts on CNBC attempting to justify Facebook's pre-IPO value of nearly $100 billion.  One analyst stated that by valuing Facebook’s 900 million users at $100 each results in a value of $90 billion.  The problem is that Facebook does not earn $100 per user.  Facebook’s total revenue per user is currently about $4.50.  To place this in context CNBC stated that Netflix earns on average $150 a year per subscriber for their video rental business.  Using this metric to value Netflix would give it a value of $3.5 billion based on 23.3 million subscribers.  At Netflix’s recent stock quotation of $63.42, its value is approximately $3.5 billion compared to a value of $63 billion for Facebook at $28 per share.  Finally, Netflix is currently trading at a price of 21.5 times earnings while Facebook is trading at 69 times earnings.  This is a very high multiple and Facebook will have to demonstrate that it can justify such a value.

No one knows what the future holds for Facebook.  The company has a strong balance sheet and is flush with cash and could get into new businesses (e.g., smart phones), make acquisitions and make changes to their business model.  Getting in at $38, $42 or $28 a share could prove to be a great deal or a real turkey….only time will tell.