1. The premiere clients of Goldman Sachs and Morgan Stanley who bought into the lie that FB should trade at >100:1 P/E; and
2. Facebook.
(1) I don't care about. (2) is the interesting one. You'll note that I don't include the employees in the list of injured parties. They're largely in a lockout anyway (I assume?). Whether it opens at $38 and drops to $30 or starts at $20 and climbs to $30 is of little consequence.
Facebook strategically seems concerned with only two companies: Google (disclaimer: I work for Google) and Apple, both of which have established, proven businesses and strategic assets in Internet and mobile going forward.
Facebook is a platform company without a mobile platform in a world becoming increasingly mobile.
Facebook has a lot of cheerleaders, optimists and pundits all backing this idea that the potential of all this data is huge, so much so that I believe they started to believe their own positive press. It's an easy trap to fall into.
But make no mistake: this is bad for Facebook. Sure some investors, Zuck and (maybe?) some employees made a few more dollars but Facebook doesn't need the money and neither do most of the investors. But that's incredibly shortsighted.
Facebook's ability to retain and attract talent and make stock-based acquisitions is in large part determined by the health and outlook of their stock. If they'd IPOed for $20-25 and jumped to $30 then they would have a lot of momentum behind them.
Instead the press is "how low will it go?" What kind of position is that to be in if, say, you're trying to negotiate a $1B+ stock-based acquisition?
Anyway, I'm glad about this drop. Not out of any kind of schadenfreude but because the market is acting... rationally. These P/Es were never justified and instead of not mattering and the stock skyrocketing anyway (which would happen were we in a bubble, which we are not), the stock is seeking a more appropriate level.
This is good for us, the tech industry and the market and the fact that some choice clients of Goldman Sachs and Morgan Stanley got bilked along the way is just gravy as far as I'm concerned.
EDIT: to clarify, I don't really have a position on what the appropriate level is other than $38 is and was too high. It could still well go lower than $30.
> Anyway, I'm glad about this drop. Not out of any kind of schadenfreude but because the market is acting... rationally. These P/Es were never justified and instead of not mattering and the stock skyrocketing anyway (which would happen were we in a bubble, which we are not), the stock is seeking a more appropriate level.
Agreed entirely. Everyone's been acting disappointed by the lack of an IPO extravaganza, but that would have been horrifying-- this drop should be heartening to anyone in tech.
Honest question: Why do you think that a share price of $30 is appropriate? Facebook still has a P/E more 6 times that of Google or Apple. To me (I don't understand a lot about the stock market), $30 sounds just as arbitrary as $38.
The honest-to-goodness justification you're going to hear is that Facebook is a nascent company, the potential earnings of which are only loosely a function of current earnings. That's to be contrasted with the likes of Google, Apple, and others as those tech staples have more predictable future earnings potential, which is at least relatively more bounded by current streams of income from reliable businesses.
NOTE: This is not to say I think a P/E of 100 was remotely justified.
You shouldn't really look at stock price (it's an arbitrary number). You should instead look at Market Value - should FB be worth 80bn when Google is worth 200?
The problem is that mobile is just one of their problems. They need to increase their monetization by an order of magnitude per user. This will require them going from a niche advertiser to taking over a significant fraction of all worldwide ad revenue, this is no small feat. They also need to tackle mobile better and respond to all the other competitive threats that will come their way in the next decade.
They have several thousand employees and a few billion in cash now. They need to pivot and scramble like crazy. If they don't they will end up on the wrong side of the inflection point and on a glide slope to obsolescence. I don't get the sense that people inside facebook see things the same way, I think they see themselves as the crowned king of social, and with the IPO they are transitioning to being a value company, which could not be more wrong.
"This will require them going from a niche advertiser to taking over a significant fraction of all worldwide ad revenue, this is no small feat."
But it is small for Facebook. They already have the footprint with over 9 million sites all running the Like button. Utilizing that same JS they can have a 'Social Adsense' revenue stream overnight. They can potentially grab the search queries from the headers and have implicit and explicit data to target off of (the holy grail of targeting).
And that may allow them to increase their ad revenue, perhaps even a lot. But is it enough to take control of fully 1/10th to 1/5th of all advertising spending for all media (print, television, radio, billboards, and online) for the entire world? Imagining that capturing that much of the market is a sure thing is just silly. Are they going to be able to get circa $20 billion in ad revenue a year from the Asian market? Within the next 10 years? How?
By getting more global marketshare and by maximizing the ARPU for North American users (credits & payments). They can get more global marketshare by striking a deal with China (~500M internet users) and increased growth in Russia (~100M).
They are also going to be tapping into a new market (mobile advertising) which is a market that is seeing 1.5x-2x yoy growth. Open Graph has already been proven to propel apps that use it to the top 10 of the Apple App Store. With apps paying $1 to $5 per user, Facebook is an interesting position where they can be a HUGE channel for these app companies to spend their money.
I would argue that the drop isn't from the market acting rationally at all, but in response to yet more hype supplied by the press, specifically the "how low will it go?" narrative you mention.
I disagree. While the market hasn't been acting too rationally in general over the last few years, FB dropping like a rock is actually a fairly rational response to their circumstances.
FB made less money in Q1 2012 than in Q1 2011. That was reported by them before the IPO. FB blamed it on the fact that more users are accessing Facebook through their mobile clients, which don't get them as much advertising money. Normal response to these kinds of reports is for the stock price to drop.
There's also the fact that they were horrendously overvalued in the first place. Facebook is quite possibly the most mature tech company to ever IPO. They already have their sources of income. They have arguably saturated their target market(1/6th of the human race has created accounts), and really don't have that much farther to grow, without seriously monetizing their current users. Unfortunately, as FB and all the other social network companies have found out, it's difficult to get more money out of your users without growing the user pool. Facebook can't grow their userbase exponentially, which really puts a lot of doubt on their future growth potential.
My gut feeling is that the IPO was not driven by Facebook needing the money(which would be normal), but that all the private investors and VC funds wanted to get out. They wanted as much money as possible, which would explain the high valuation.
Normally a private company cannot have most than 500 stockholders. Facebook obviously has more than that number of employees. They previously applied for and got an exemption from the SEC on the basis that most stockholders were employees.
That all changed early last year with Goldman Sachs' "investment vehicle" of holding stock on behalf of clients (a move the SEC will see through). That was deliberately done in January as it put a clock on filing for IPO by April this year, which is what happened.
Now they may have wanted to go public anyway. Whether or not they wanted to they signaled this event over a year ago.
>Normally a private company cannot have more than 500 stockholders.
I'm sure that you probably know this but just to be clear, the 500 shareholder limit is about whether or not a company has to report certain financial data to the SEC, not whether or not they must be publically traded.
If the market would have acted rationally, FB would never have IPO'd at 38 per share given their profits. Being valued at 105 billion dollar when your profit is only around 1 billion a year is insane, especially when you also account for the highly volatile nature of social networking (FB might be replaced by something we've never heard about in a couple of years)
>But make no mistake: this is bad for Facebook. Sure some investors, Zuck and (maybe?) some employees made a few more dollars but Facebook doesn't need the money and neither do most of the investors. But that's incredibly shortsighted.
>Facebook's ability to retain and attract talent and make stock-based acquisitions is in large part determined by the health and outlook of their stock. If they'd IPOed for $20-25 and jumped to $30 then they would have a lot of momentum behind them.
Why do you think the momentum of their stock has an effect on facebook's ability to attract talent? That's certainly not something I'm looking at (future stock price, yes; current momentum, no). Facebook's stock performance thus far has not changed my view of the potential future success of the company, and I think anyone who has actually done their homework regarding the Facebook valuation would feel the same way.
Option based compensation usually has a strike price at the value of the company around the point of hiring. Options are more volatile than stock. If the share price drops further, the options would be worthless. As the share price rises, the option value rises even faster.
To get and keep talent you need not just a good work environment but cold, hard cash. Paying employees with stock options and grants on a stock on the way up is a very efficient way to encourage people to work for you or to stay working for you. You can also pay people with actual cash, but that's significantly more expensive to match the same level of reward. People who worked through the elbow at Microsoft, Google, Amazon, etc. became millionaires. And there are plenty more elbows out there for the taking in silicon valley, in new york, and elsewhere. It can be hard to compete for and retain employees who are talented enough to earn their millions by seeking out some other company. This is a huge problem at Microsoft, for example, where the stock has been flat for a decade.
Certainly there are many good reasons to work at facebook, but how many of those reasons can make up for missing out on millions of dollars? This is all the more relevant right now because so many of the early employees have gotten their millions through the IPO, and that has all the makings of creating a cultural divide in the company between those who got theirs and those who haven't, and won't.
Clients of investment banks in an IPO have a choice to invest or pass on the deal. There are many things they consider when making this decision, and the price of the deal is one of those. Assuming they are not given inaccurate information, they are not getting "bilked" by the banks if the stock goes down in the aftermarket. The clients know this is a possibility, and they chose to invest at $38 per share. Right now those shares are worth less than the offer price, which is disappointing to the clients, but they made the decision to invest at $38 per share.
I think what cletus is getting at is that the orchestrated IPO pop has become SOP for tech IPOs, and it's nice to see it fallible for a variety of reasons:
0. Keeps people guessing.
1. The company got most of its IPO market value, instead of having a portion extracted by Wall St. insiders.
2. The 'bubble' got popped early, which is probably a good thing for most everyone but Wall Street insiders.
3. Wall Street's ability to orchestrate asset bubbles, whether coordinated or purely emergent, and profit off them at the expense of potential crashes and financial crisies later, just took a hit.
4. There's less or no irrational exuberance this time around. The market may actually have learned from the 2000 and 2007/8 crashes.
Can anyone explain to me how the P/E ratio is a meaningful metric for a company's stock price and what it "should be" at when that company does not distribute earnings to the shareholders?
I don't understand why this metric is tossed around for stocks in which the regular shareholders receive no compensation for the shares owned (nor have any voting power for that matter). Owning stock in these companies seems like a pure speculation move, as the only upside to be seen in purchasing shares is that one day other people will value the share higher than the day you bought it.
Can anyone explain to me how the P/E ratio is a meaningful metric for a company's stock price and what it "should be" at when that company does not distribute earnings to the shareholders?
There are two ways to gauge the value of a company. One way (the way to which you allude) is to buy it and hope that in the future, someone thinks it's worth more than what you paid for it. Some people call this the Greater Fool theory.
The other way is to treat owning shares like owning part of a business. (You might hear about this as the Graham-Dodd or Graham-Dodd-Buffett model.) In this case you consider the value of the company as the current liquidation value of the company's assets plus the total amount of free cash the business can produce over its useful lifespan.
The math of that valuation gets a little bit interesting, because if you project the free cash growth into the future ten or twenty years, you can use a present value calculation to get a fair price for the company right now. Divide that by the number of outstanding shares and you get a target price per share.
One of the flaws of this method is that you need to have a sane sense of the growth rate of free cash, so you'd better base that on a stable and measurable history, and you have to verify that against sanity and the company's published plans.
Graham's real insight was saying "If you do all that work, also add a significant margin of safety to account for any flaws in your calculations."
Of course you shouldn't use reported earnings for these calculations; they're far too easy to manipulate under GAAP and accrual accounting. Even so, finding realistic numbers and ruling out most stocks as overvalued is relatively easy.
(I'm working on a financial analysis site right now.)
So does this mean that if you use the Graham-Dodd-Buffet model of valuation, a company that pays a dividend to shareholders would get a higher valuation (all other factors being equal) than the hypothetical same company that does not pay dividends?
Because if the company keeps the cash it still is part of the company worth calculation (unless investors expect managers to steal it in the future). Not issuing a dividend is also a signal that the company believes it can earn a better return on the cash then if it were returned to the shareholder.
Yes and no. Free cash paid out in dividends is free cash not invested back in the company. Presumably free cash invested in the company could help the company grow to produce even more free cash in subsequent years.
If you measure only the average growth in free cash for the trailing ten years, you're ignoring whether the company pays out dividends. You only measure how much free cash it generates. Dividends are irrelevant to the free cash growth rate.
If you measure something like a return on invested capital, you measure how much actual cash the business reinvests in itself and how effective it is at free cash growth from that reinvestment. That metric does account for dividends, because money paid out in dividends or used to buy back stock is obviously no longer available for reinvestment.
edit With that said, some investors value regular and reliable dividends more highly than the fluctuations of the market's semi-random valuation of a stock at any point in time. If you're confident that Coca-Cola will always pay, for example, 4% of what you paid for a share in dividends every year, that stability might be worth something to you.
That's psychology and harder to measure and predict than numbers from financial reports filed with the SEC. You might get some interesting data if you calculate the time value of that money--is KO more valuable because you can get $0.13 per share quarterly in dividends starting now rather than holding onto it for up to ten years to make even more money? That's the kind of decision individual investors have to make for themselves.
I treat dividends as bonuses rather than expectations, but that's my own investment philosophy.
Just an amateur, so speculation abound. But presumably, on the basis that other investors that you hope will value it higher will use the P/E ratio as a metric as well, and that it gives a comparative metric between "similar" companies. E.g. it's an often used metric just because it's an often used metric.
I would also think that it's easier to build a mobile app/social network that competes with Facebook than it is to build a mobile OS/device that competes with Android/iOS.
Hmmm. It's very easy to build a mobile platform to compete with Android -- fork it. This is Google's problem in China and with the Kindle Fire. This is probably why Google's "success" in mobile hasn't been reflected by huge stock market gains.
The success of Android forks has also impacted iOS to some hard to measure extent (were it not for Android and Android forks, Apple would, I think, be even more successful in the mobile spaces it plays in).
Facebook is a platform company without a mobile platform in a world becoming increasingly mobile.
I agree that Facebook sees mobile as a serious problem, as evidenced by their planned foray into mobile phones, however I think it's a distraction and will be a money pit for them. Much as Microsoft felt they had to get into search to compete against Google (they still don't compete in a meaningful way), Facebook feels they have to compete in the mobile space, but will never be able to execute as well as Apple on hardware or Google on integration with web services. It's very hard to get right, and I doubt very much they have the product design talent and supply chain experience to pull it off consistently and long-term, and it is way off their main area of competence. I'd be very surprised if they do well with a mobile platform given all the challenges it presents - they should work on improving their offerings on the main platforms instead, otherwise they will have 4 Facebook app binaries instead of 3 to maintain, and no obvious advantage as most of the users will not be on their phone.
Mobile is a complement to other devices, and a way of accessing the web, it is not a new segment which is orthogonal to web use - I'd argue mobile has only become popular as handsets became capable of accessing the web fully, and mobile apps may or may not win out over websites for some services, but for websites like Facebook they offer no real advantages save more access to user hardware for uploading pics etc. - something that a website can offer with an API and third party apps. Mobile apps are of course competing with the desktop, and will continue to do so, but not really with websites, they usually complement websites and use their APIs, not replace them.
Facebook's real problem, and real competitor, is the open web.
Facebook has been opposed to opening up from the beginning, and has pursued a very successful strategy of corralling their users, and requiring anyone who wants to interact with the service to sign in and share their info - I'm constantly plagued by their login messages when I visit a page. At some point this walled garden is going to start feeling very restrictive - it only works if there is a continually growing, or at least not shrinking, pool of people using the service - if it feels like everyone is logged in all the time, otherwise it becomes a bit of an echo chamber, infested with spambots and spammy companies like Zynga, and if your friends don't bother to check it any more or post, what's the point?
I suspect as the gloss wears off Facebook, particularly if they make a foray into mobile and waste energy there, it will be harder and harder to keep users inside their bounded version of the web, and competitors without the barrier to entry for readers (sign-in required for all essential services), will come in and capture user interest, as pinterest has for example.
As to their stock price, given their current revenue/profits and potential future profits, I'm astounded anyone still believes it was worth > $20B in today's money.
This kind of statement first has to be qualified as "two parties immediately hurt by this. It is common for price moves in a well known stock to exert a strong psychological influence on similar stocks and on the broader market. All markets are subject to flux but where things have fluxed to currently, it seems quite possible that others could be "injured" here.
Sure Facebook's move could, might, be good for the tech industry if investor perception separated Facebook from the rest of tech industry. If not, it is easy for things to go from irrational optimism to irrational pessimism.
>1. The premiere clients of Goldman Sachs and Morgan Stanley who bought into the lie that FB should trade at >100:1 P/E; and
>2. Facebook.
Wrong. FB did crazy volume on the first day at $45 to $38. 580 million shares were traded and the total number of shares in IPO was only ~470MM IIRC. That does not mean that the big clients unloaded all their shares because of shares getting traded multiple times and by HFT, but the really smart ones(most of them I would guess) sold their shares above $38 and some even went short and are making bank now, while the retail investors and other financial companies who bought the first day are left holding the bag.
If PE is so important why is LinkedIn http://www.google.com/finance?q=NYSE%3ALNKD not getting bashed as fb is. Both are kind of social networks (used differently with different target audience) . LinkedIn is trading at 600+ PE.
As ever a useful analysis, however what may I ask is it that you do at Google of relevance to armchair generalizing like this, that causes you to disclose your employment every time you post? It seems to me it detracts from the merit of otherwise consistently excellent write ups, and almost encourages suspicion of bias.
I feel it's always better to disclose any potential biases or conflicts of interest up front. Cletus could have appended it to the end of his comment, but many readers might TLDR and miss it.
Because the app has been out since 2008, gone through multiple iterations, currently holds a 2-star rating on the App Store, and still hasn't managed to monetize 60% of their impressions.
So what you mean to say is, we have here a company whose traffic has been bleeding off their monetized, desktop platform into the unmonetized, mobile platform that has existed for four years, and they still haven't done anything about it?
Are we still talking about FB? I swear this sounds more like RIM.
Right, so Facebook could potentially grow by 150%, maybe. But their valuation is predicated on them growing by a factor of 10x or more. That's the issue.
Now take the 9 million sites with the Like button and throw in some extra Javascript for a 'Social Adsense' product. Now they have implicit and explicit data to target off of. There's your 10x growth in revenue.
1. The premiere clients of Goldman Sachs and Morgan Stanley who bought into the lie that FB should trade at >100:1 P/E; and
2. Facebook.
(1) I don't care about. (2) is the interesting one. You'll note that I don't include the employees in the list of injured parties. They're largely in a lockout anyway (I assume?). Whether it opens at $38 and drops to $30 or starts at $20 and climbs to $30 is of little consequence.
Facebook strategically seems concerned with only two companies: Google (disclaimer: I work for Google) and Apple, both of which have established, proven businesses and strategic assets in Internet and mobile going forward.
Facebook is a platform company without a mobile platform in a world becoming increasingly mobile.
Facebook has a lot of cheerleaders, optimists and pundits all backing this idea that the potential of all this data is huge, so much so that I believe they started to believe their own positive press. It's an easy trap to fall into.
But make no mistake: this is bad for Facebook. Sure some investors, Zuck and (maybe?) some employees made a few more dollars but Facebook doesn't need the money and neither do most of the investors. But that's incredibly shortsighted.
Facebook's ability to retain and attract talent and make stock-based acquisitions is in large part determined by the health and outlook of their stock. If they'd IPOed for $20-25 and jumped to $30 then they would have a lot of momentum behind them.
Instead the press is "how low will it go?" What kind of position is that to be in if, say, you're trying to negotiate a $1B+ stock-based acquisition?
Anyway, I'm glad about this drop. Not out of any kind of schadenfreude but because the market is acting... rationally. These P/Es were never justified and instead of not mattering and the stock skyrocketing anyway (which would happen were we in a bubble, which we are not), the stock is seeking a more appropriate level.
This is good for us, the tech industry and the market and the fact that some choice clients of Goldman Sachs and Morgan Stanley got bilked along the way is just gravy as far as I'm concerned.
EDIT: to clarify, I don't really have a position on what the appropriate level is other than $38 is and was too high. It could still well go lower than $30.