Investing In Facebook

Dave Sather’s Money Matters

For quite some time now, the calls have come in from people asking us if we’re going to buy shares of Facebook at their initial public offering next month.  Whether a fan of the social networking site or not, this is an investment decision that should be fully evaluated from a business perspective. For us, there are two issues that quickly come to mind.

The first is that in buying shares of Facebook you are allocating money hoping for a good rate of return. In the most basic of terms, you are buying a business and trying to determine what a fair price should be. To begin this assessment, some simple Aggie math is helpful.

By all accounts, it appears that the initial public offering for Facebook will assess a value on the entire company of more than $100 billion. That is a very stout number and great if you are currently a Facebook insider looking for a monster payday. However, if you are just a normal investor, what exactly are you getting? Remember, the long term value of any business is the compilation of its earnings. As such, you don’t want to overpay for earnings.

Based upon last year’s figures, Facebook produced revenues of $3.7 billion. At a $100 billion value, Facebook would trade for twenty seven times revenues. Ouch! In comparison, you can buy either Wal-Mart or Exxon for less than one times revenues. Obviously, neither Wal-Mart nor Exxon are expected to grow as fast as Facebook, but is the social networker really twenty seven times better than the world’s largest energy company or largest retailer?

Out of the $3.7 billion in revenues, Facebook reported net earnings of $1.1 billion. Again, a $100 billion value would put Facebook at ninety one times earnings. We haven’t seen numbers like that since the dot com craze—and we all remember how that ended.

Wal-Mart, Walgreens, Exxon and Microsoft all trade for eleven times earnings or less. As such, an investor has to ask themselves whether or not Facebook is really nine times as good as any of these highly predictable companies with tremendous staying power.

Setting valuations aside for a second, an investor should also consider the corporate structure of Facebook.  Mark Zuckerberg, Facebook’s founder, made news this week when he made a $1 billion acquisition of a privately held company called Instagram.

What made this acquisition unusual is that Instagram has thirteen employees and zero revenues. Let me reiterate that—zero revenues. As such, Zuckerberg paid $1 billion for a concept! At those prices, I have a few concepts I’d like to sell too.

More oddly though was the fact that there was no bidding war for Instagram—just Zuckerberg and Facebook’s corporate checkbook. There was no consultation with Facebook’s board of directors, attorneys or other advisors. They didn’t even know Zuckerberg bought the company until they heard about it on the news.

How can this be? Although Zuckerberg only owns 28% of the common stock, he owns 57% of the voting shares. As such, he controls 100% of the company. Given this, an investor in Facebook should expect no oversight from a board of directors, no compensation committee and no independent directors. All you get is Mark Zuckerberg.

None of this means Facebook will flop as an investment. It just means that any potential investor must be aware of the risks that are plainly evident.