Facebook hubub worrisome

This week the investment world was all atwitter about a round of private financing done on behalf of Facebook.  The offering documents for the round of money raising for the company valued Facebook at over $50 billion.  Is this valuation reasonable?  And what does this valuation remind me of?

First, the $50 billion valuation is higher than a business like Time Warner.  Time Warner has decades worth of valuable content and also has many very well known, important and stable brands.  Multiple brands means a diversified portfolio with lots of potential ways to earn money and less risk than Facebook would likely have.

Second, the offering papers showed Facebook had $1.2 billion of revenues in the first 9 months of 2010.  If we conservatively annualize those revenues – that is, if we assume growth was even throughout the four quarters of 2010 – then annual revenues at Facebook were probably around $1.6 billion.  This is calculated as: $1.2 billion x 4/3 = $1.6 billion.  Now what kind of price to sales is that $50 billion assumed value?  31.25x (!).

Typically it is considered beyond aggressive to value a business beyond 5x revenues.  Hmmm.

Third, the offering documents showed that Facebook had earnings of $355 million in the first 9 months of 2010.  Remember how to annualize the figure?  $355 million x 4/3 = estimated full year 2010 earnings of $473.3 million.  So what kind of price/earnings ratio does that $50 billion number imply?  105.6x (!).

Analysis:Can I just say that this worries me?  It’s not that Facebook isn’t wonderful and that it isn’t amazing and the cat’s meow and all of that.  No, it’s that Facebook is being valued as a monopolist of tremendous proportions.  It’s that, as an investor, it is very difficult to make money in a 106x P/E business.  When I see valuation numbers like this I am reminded of that era of craziness, the dot.com era.  And what is worrisome to me is that some of the innate human silliness (i.e. foolishness and greed) that was so apparent in the dot.com era is apparently still not been bled out of investors.  The Facebook deal is even more disappointing when you consider that the investors that were allowed to participate in the offering are very, very wealthy, presumably sophisticated, investors.

I have been hoping that the Great Recession had seared into the minds of investors, at least for one generation, that speculative bubbles are a bad thing.  This is the first piece of evidence that indicates that the ugliness that nearly resulted in another Great Depression is still pretty close to the surface.  Sigh!

Yes, I know Facebook is in its infancy.  That it may grow into those valuation metrics.  That is may be the second coming.  However, as I caution about in my book, The Intuitive Investor, investing in archetypes (the Rocket Ship) is very dangerous.  The danger is that reason starts to fail, and instead the imagination runs rampant.

Importance grade:3; Facebook is the first data that contradicts all of the other data that people have been weened of bubble-mentality.  It may be that this is a harbinger.  It may be that this is just a singular occurrence for, what apparently is, a singular company.  I hope so.

Jason