Figuring out the right price for Facebook stock isn’t easy
At $38 a pop, nobody liked Facebook. So what is the right price for the world’s largest social network?
Facebook Inc. shares have fallen 16.5% since the company’s opening day flop May 18, closing Friday at $31.91. Accusations of wrongdoing are flying, as are lawsuits filed by angry shareholders.
Despite the outcry, few question that Facebook is an enormously successful start-up with excellent prospects for growth. Figuring out whether the price is too high, or too low, is the art and science of stock investing — and there are ample opinions on both sides.
Those who argue that the price is too high say Facebook’s slowing revenue growth, difficulty in making money on mobile platforms and saturated user base in the most lucrative advertising markets are all drags on the stock’s prospects. The Facebook bulls counter that the dominant social network is essentially a utility with few peers in its ability to target specific demographics.
Which view is right? Independent analysts have begun weighing in, issuing price targets ranging from below $25 a share to nearly $50, while bloggers, day traders and others have begun trotting out valuations that pin Facebook as low as $6 a share.
“We still think it’s an incredibly exciting company, but it’s still very risky,” said Brian Wiesel, senior analyst at Pivotal Research Group. He issued a “sell” rating the day that Facebook started trading, pegging its target price at $30.
Opening at $38 a share put Facebook’s valuation at $104 billion, roughly 100 times its 2011 earnings. By comparison, both Apple Inc. and Google Inc. trade at roughly 20 times last year’s earnings, which might support the notion that the price was high.
Investors willing to purchase Facebook at current prices, however, are probably ignoring that contrast because of long-term faith in the Menlo Park, Calif., company’s growth potential, something Herman Leung of SIG Susquehanna touted in awarding a $48 target price for its stock Monday.
“It’s going to be volatile over the next 12 months,” Leung said. “But I believe this company will execute and has very good opportunity in front of it.”
He pointed out that Facebook’s $3 billion in advertising revenue last year represents less than 1% of the $500 billion worldwide spent annually on advertising and sees huge potential for the company to take a bigger share of that.
That idea — that an investment in Facebook now is getting in early — is undercut by the fact that, by some measures, it already is a fairly mature company.
Facebook was able to put off its initial public offering longer than other prominent Silicon Valley start-ups. Ordinarily, company employees and investors are eager to go public so that they can cash out their stock awards. Google, for instance, went public six years after it was founded. But Facebook was able to hold out for eight years, thanks in large part to the advent of marketplaces for privately held shares.
Last week, SharesPost, one of two leading exchanges for private stock, said 3.2 million Facebook shares had been sold on its platform between March 2011 and March 2012 at prices between $31.50 and $44.10 a share. Second Market, another such platform, said that it started selling Facebook shares in April 2008 and that 79% of the sellers prior to the IPO were Facebook employees.
Eventually Facebook crossed a securities threshold requiring public financial disclosures for any company with more than 500 shareholders; by the time the social network finally did go public, however, it was much further along the growth curve, bringing in about $1 billion a quarter in revenue, compared with $700 million for Google when it went public in 2004 and $16 million for Amazon.com Inc. in 1997.
What’s more, Facebook’s revenue increased only 45% for the first quarter of this year. Google, at the time of its IPO, had revenue growing at a 125% clip, a rate far more in line with a high-growth company.
Laura Martin, an analyst at Needham & Co., believes that other metrics set Facebook apart and make conventional financial comparisons less important.
She justifies her “buy” rating and $40 price target by pointing to the extraordinary amount of time users spend on the site and the lack of a serious rival in the social network sphere. Facebook’s roughly 525 million daily active users spend an average of 14 minutes a day on the site, triple the amount of time spent on Google.
“We believe that time spent equals money,” said Martin, who predicts that Facebook could grow advertising revenue to $14 billion in 2013.
And while revenue growth may be slowing, profit margins are not. Facebook’s margins stood at 47.3% in 2011, up from 33.7% in 2009, and it has managed to remain relatively agile, with only 3,500 employees compared with 32,000 at Google and 27,000 at EBay Inc.
“I think this company should be able to convert a larger percent of its revenue to cash flow than anyone else,” Martin added.
Facebook critics point to a string of potential negatives: user saturation in North American and European markets, leaving its main user growth in the developing world, which has less value to advertisers; the risk that regulation and privacy laws could undermine its business model; and its inability to enter China, one of the world’s most important markets.
There is also considerable concern about Facebook’s management structure.
Despite the company going public, Facebook founder and Chief Executive Mark Zuckerberg controls more than 57% of its voting shares. And his recent decision to purchase Instagram, a company with no revenue, for $1 billion without consulting Facebook’s board is a frightening prospect to pension and insurance fund managers, who like to see conservative business behavior.
But perhaps the greatest concern, and one that is given voice in Facebook’s own securities filings, is its difficulty in making money selling ads on mobile platforms such as cellphones and tablets.
“Growth in use of Facebook through our mobile products, where our ability to monetize is unproven, as a substitute for use on personal computers may negatively affect our revenue and financial results,” Facebook said in Securities and Exchange Commission filings.
Henry Blodget, a former analyst turned finance blogger, figured Facebook should have a valuation between $16 and $24 a share. He said that is still a premium over the price of more established tech stocks, although he left open the possibility that the company could roll out new products to justify a higher price.
In the meantime, analyst Wiesel said, he’ll turn to more established companies.
“If you told me Facebook was available at $30 and Google at $600, I’d take Google all day,” he said.
