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Originally published Friday, May 18, 2012 at 10:08 PM

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Facebook's next task: proving itself

The lackluster performance of the company's stock on the first day of trading may be an early sign that the market is not fully comfortable valuing Facebook at $105 billion, a number that assumes the company is capable of producing enormous profits.

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Facebook now has some proving to do.

On its first day of trading as a public company, Facebook did not deliver the pop that many investors have come to expect from Internet companies. The lackluster performance may be an early sign the market is not fully comfortable valuing Facebook at $105 billion, a number that assumes the company is capable of producing enormous profits.

After technical glitches delayed the start of Facebook's trading by one-half hour, one of the most anticipated initial public offerings in Wall Street history ended with the company's stock at $38.23, up 23 cents from Thursday night's pricing.

"Going public is an important milestone in our history," 28-year-old CEO Mark Zuckerberg said before pushing a button that rang Nasdaq's opening bell from company headquarters in Menlo Park, Calif. "But here's the thing: Our mission isn't to be a public company. Our mission is to make the world more open and connected."

Still, the increase of six-tenths of 1 percent was a letdown for many seeking a big, first-day pop in Facebook's share price.

"This is like kissing your sister," said John Fitzgibbon, founder of IPO Scoop, a research firm. "With all the drumbeats and hype, I don't think there'll be barroom bragging tonight."

The small jump in price, however, could be seen as an indication Facebook and investment banks priced the stock in an appropriate range.

It also was good for ordinary investors who mostly are shut out from the IPO price. They had a chance to buy all day at a price not much above $38.

And it was good for early investors in the company, who owned more than half the 421 million shares made available in the IPO. Had the stock shot to $60, those early investors would have felt they hadn't gotten enough money for their stakes.

Many of those investors who chose to friend Facebook on Friday expect it to be their best friend for a long time. Yet stock-market history shows this ardor evaporates when a highly valued company disappoints.

"At $100 billion, everything has to go according to plan," said Aswath Damodaran, a professor of finance at New York University. He said he thinks the company could be worth about one-third less.

In isolation, $105 billion does not mean much. That value therefore has to be compared with Facebook's earnings and sales. And that is when it begins to look like the company is priced for perfection.

Facebook traded Friday at 108 times its earnings in the 12 months through March, compared with 14 times for the overall market and 18 times for Google, Facebook's main competitor for online advertising. On sales, Facebook's stock price also looks rich, even alongside similar companies. LinkedIn, the social network, trades at 17 times sales. Facebook far exceeds that at 26 times.

"I can't justify it," said Anup Srivastava, an assistant professor at the Kellogg School of Management. "Facebook is a great business, but it's worth around $25 billion."

There is one measure upon which Facebook does not look the most expensive — how much value the market places on each of its users. The company had 806 million worldwide visitors in March, according to comScore, a data firm. The market values each of those at $130, compared with $172 at Google. But there is a good reason Google is higher. It makes $35 in revenue for each user, seven times more than Facebook.

Young companies often start out trading with absurd-looking valuations, but then fulfill them as they produce earnings that investors expect. Google went public in 2004 at a similar valuation. Its shares since have gone up seven times.

But Facebook's business model is not as clear as Google's, Damodaran says. He says it would be a mistake to assume that, just because Facebook has millions of users, it can make strongly increasing profits for the foreseeable future.

"It's like a Chinese company that says it's worth a lot because there are a billion people in China," Damodaran said.

The next big market milestone for Facebook will occur in early summer. That event will be Facebook's first quarterly earnings report as a public company. Shares of other Internet companies with recent IPOs have fallen after releasing earnings that did not meet expectations.

Investors will be scouring the numbers for evidence Facebook is finding new ways of generating advertising revenue, which accounts for 85 percent of total sales.

Investors may treat Facebook like Amazon and award it a stratospheric valuation even in the absence of strong profit growth. Amazon has this favored status mainly because investors say they believe its huge and hard-to-assail presence in online shopping give it the time to generate bigger earnings. Likewise, no social networks look like becoming close rivals to Facebook.

But the danger for Facebook is that, if its shares start falling soon, more skepticism may arise. Facebook may find it difficult to win back the faith among investors.

"Facebook has a great product, but it's not a great company yet," Damodaran said.

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