FACEBOOK’S VALUATION DEFIES LOGIC
This article also available on Forbes
As Facebook prepares to go public over the next few months, a circus of rational minded pundits attempting to apply logic based on the S-1 filing emerges. These commentators, analysts and traders are making the most out of their fascination with well thought out investment analysis that, in all likelihood, has garnered returns for their portfolio that are no better than a yellow baboon throwing darts.
The markets have not and will not ever function on logic. It is an illogical mechanism that feeds on our propensity for logical thought. The more watched the situation, the more deceptive, illogical and counter-intuitive the market becomes. This being the fact, why then are so many attempting to apply logic in determining whether the valuation of one of the most anticipated IPOs ever, in Facebook, is justified?
In order to determine whether Facebook is fit for investment all logical thought should be suspended in favor of seemingly illogical assumptions of the current company, its future potential and the potential of the economy as a whole going forward. The S-1 filing and 99% of articles you have read should be crumpled up into a paper ball and thrown at your children when they don't listen or your neighbor when he tells you a joke that isn't funny. Allow your mind to run in directions that would cause any "rational" person to question your judgement and the truth about a company like Facebook will become apparent.
Let's first look at the logical facts that are causing investor panties to get caught up in a bunch:
1. The valuation - $100 billion potentially. That's too much. A P/E of a million. How? Why?
2. The environment - Wall Street feeds on selling investors stock at high prices so insiders can exit at a favorable price. All that is happening here is that insiders are being provided a liquid environment from which they can feed you and I stock.
3. The company - the barrier to entry isn't great here. Look what happened to MySpace. FOX bought it for over $500 million and today it worth no more than a bean burrito. Facebook will soon disappear in favor of YourFace or SpaceBook.
All three of these seemingly logical concerns are born out of the environment we are in. When GOOG came public in 2004, the same arguments were being bantered around without much thought that the premium that was being assigned to the shares was in anticipation of what was to come. Yes, GOOG came public with less of a premium than Facebook will and yes, GOOG came public with a lot less shares outstanding, making it easier to drive the price up in the years following the IPO. However, the psychological backdrop was much the same. Skepticism amongst rational thinkers ran high.
The current psychology of the markets is one that is born out of the constant cycle of defeat that investors have encountered over the past 12 years. It has been a seemingly endless cycle of small glimmers of hope, followed by black holes of depression relating to fraud, bubbles collapsing, economies coming to a halt and debt contracting at a record pace. The retail investor has all but disappeared. The average hedge fund manager has been exposed as no better than any retail investor. What's left are institutions fighting amongst each other for whatever morsels are left.
Given this psychological backdrop it is only natural that investors would tend to grasp onto a logical, well-thought out thesis with respect to every potential investment. Especially one as high profile as Facebook.
That leads me to look at Facebook from a completely illogical point of view. Let's look at the possibilities here and why this company could be justified in its premium when it comes to market:
- $100 billion valuation puts Facebook in the top tier of companies worldwide. You have to ask yourself what incentive do the underwriters have to bring a company public with such a premium? There is an abundance of skepticism with relation to Wall Street firms currently. The last thing they would want is to have Facebook debut with a $100 billion market cap and then fall by 50% over the next 6 months.
Most are looking at the market cap upon debut with skepticism. But it may warrant optimism as there is revenue growth being factored into the company with its debut price that is incomprehensible to most investors. Remember when GOOG went public its revenue and profit growth skyrocketed in the years that followed. Facebook is fully capable of achieving the same astronomical levels of revenue and profit growth in the years to come.
Their revenue streams are still being defined and there are countless opportunities to capitalize on the abundance of information that Facebook has access to.
- Facebook is the single most biggest threat to GOOG. They are developing an entirely new advertising model that doesn't rely on search but rather by knowing everything about you as an individual. How powerful can the profiles of nearly a quarter of the population of Earth be to a company? How much will advertisers be willing to pay for access to such data? How will Facebook utilize this in the future to develop further steams of revenue? All questions that investors should be asking with a wide open potential for answers.
- The markets have been stuck in neutral for 12 years now. This is a long-time by any historical standard. There is reasonable expectation that there will be a new bull market emerging that readjusts what we see a "normal" market caps. In the 1980's it was rare to have a company with a market cap over $100 billion. In the current economy market caps in excess of $400 billion are held by AAPL and XOM. What will the average range of the top companies be in 5 or 10 years? Could a market cap of $800 billion or even $1 trillion become the norm for the most powerful companies? If so, the current thoughts with respect to market cap limitations could be irrelevant as the range is due for expansion. Should Facebook hold onto its market position, it will participate in this expansion of what are considered normal market capitalization for top tier companies.
- It is nearly impossible to quantify Facebook's business model as there are no comparisons. What they possess is true insight into the lives of people with access that has never been granted. GOOG only knows what you search for and tailors their services and revenues around such searches. Facebook knows not only what your interest of that particular day is, but your age, your kids ages, the restaurants you tend to go to, the type of technology you buy, the cars you talk about, how affluent your friends are, how affluent their friends are, what types of jobs you have or have had, what type of mate you are attracted to, the type of pot you smoke, how many pets you have and whether you like your spouse on a particular day. It is literally an encyclopedia of real-time data on a majority of human beings in the developed world.
How the myriad of pundits are using traditional valuation measures and an S-1 statement to come to the conclusion that Facebook should be avoided upon its debut in the face of such facts goes to show that logical thoughts should be saved for crossing the street in traffic and behavior at airports. Logical minds fail in the markets. Facebook will prove that one again.
