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Will Facebook’s IPO be a one day Circus?

Will Facebook’s IPO be a one day Circus?

Unless you live under a waterfall in the rainforests of South America, you will have heard that Facebook has lodged its S-1 (Prospectus) for a probably May 2012 IPO.  Skaffold members can look forward to Facebook being available to view in Skaffold when the team loads up all the international stocks.

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Back to our regular programming…

Hyped by the media around the world as the biggest internet IPO in history and asked whether we would ‘invest’ in Facebook, we note the following:

The company already has 500 shareholders and would have been required by the SEC to lodge financials in April.

Facebook Stock Code: FB

Maximum aggregate offering price: $5Bn

as yet, there is not sufficient valuation information listed in the S-1 filing with the SEC nor how many shares are being offered.

According to the S-1 cover:

845 million monthly active users (MAU)

483 million daily active users (DAU)

Users generated on average 2.7 billion Likes and Comments per day in Q4 2011.

100 billion friendships

250 million photos uploaded per day

Our observation:  Not a mention of any dollars yet! “likes”, “friends” and ‘uploaded photos’ are today what ‘page impressions’ and ‘visitors’ where in the tech boom of 1999/2000.

FB generated $3.7 billion in Revenue in 2011, up from $2 billion in 2010.  12 percent of Facebook’s revenue in 2011 was linked to its relationship with online gaming giant Zynga.

FB generated $1 billion in net income in 2011, up from $606 billion in 2010, a 40% growth rate, compared to the 165% growth rate from 2009’s $229m.

EBIT margin peaked at 52.3% in 2010 ($1m in EBIT on $2 billion in revenue), has since declined to 47.3% or $1.756Bn on $3.711Bn in Revenue, still incredible.

$3.9 billion in cash and marketable securities

Western world user growth is slowing but thats the law of large numbers.  Facebook says: “We believe that our rates of user and revenue growth will decline over time. For example, our annual revenue grew 154% from 2009 to 2010 and 88% from 2010 to 2011.  Historically, our user growth has been a primary driver of growth in our revenue. Our user growth and revenue growth rates will inevitably slow as we achieve higher market penetration rates, as our revenue increases to higher levels, and as we experience increased competition.”

The company still reported +60% earnings growth rates in 2011.  The key is whether users stay and whether they can be ‘monetized’ further. MAU additions peaked in 2010 when FB added 248m to a total of 608m; in 2011 it added 237MM to 845m.

On the subject of dividends FB says:  “We do not intend to pay dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the market price of our Class A common stock increases. In addition, our credit facility contains restrictions on our ability to pay dividends.”

Here’s access to the S-1: http://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm

The map of the world connected by facebook users is intriguing.  What are those pirates on the west coats of Africa doing on Facebook?

I have previously written about the forthcoming floats of internet and social media sites here: http://rogermontgomery.com/which-ipos-are-you-watching/

‘Paradigm changers’ (remember Yahoo?) have come and gone so it is essential you don’t get caught up in the hype and instead stick to the valuation approach that is the bedrock of our approach.  If you don’t know it, buy a copy of Value.able today for just $49.95.  Or to save yourself reading the last ten annual reports for every listed company, try Skaffold.

There were eight large and highly media-promoted IPOs in the last year or two (GRPN, ZNGA, LNKD, P, YOKU, DANG, AWAY, and FFN).  One analyst reported that if you could get stock in the IPO (forget it if you weren’t a major client of the lead broker or a ‘friend’ of the company) there was an average gain of 50%.  If you bought each IPO in the market on Day 1 you now have an average loss of 54% with incredibly only 1 of the 8 names (ZNGA) still holding on to gains (+11%) thanks to a rally of 15% in the last week.

We would like to go through the numbers for Facebook today and try to come up with a valuation for you.  You can do it yourself if you have a copy of Value.able.

There’s about $5.2 billion in equity, including $1bln of retained earnings.  There’s 4.1bln Class A shares and the same number of class B’s.  The preferred’s will be converted and only Class A’s sold.  We cannot calculate equity per share because the S-1 does not disclose how many shares will be issued.  ROE is about 26 per cent.  No dividends will be paid. The company states in its S-1 that it will continue to grow by acquisition as well as organically.  But the company will takeover Earth if it continues to retain profits and generates 26% returns on the incremental equity.  Assuming earnings grow at 40% and faster than the rate of return on equity, then you can expect ROE to rise.  Using these favourable metrics we reckon Facebook is worth $26-$28bln in 2012 rising to $57-$63bln in 2014.  If the IPO ‘values’ the company at $100bln as many media outlets suggest, watch out.

This paragraph from the S-1 is important:

“If you purchase shares of our Class A common stock in our initial public offering, you will experience substantial and immediate dilution.

If you purchase shares of our Class A common stock in our initial public offering, you will experience substantial and immediate dilution in the pro forma net tangible book value per share of $         per share as of December 31, 2011, based on an assumed initial public offering price of our Class A common stock of $         per share, the midpoint of the price range on the cover page of this prospectus, because the price that you pay will be substantially greater than the pro forma net tangible book value per share of the Class A common stock that you acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. You will experience additional dilution upon exercise of options to purchase common stock under our equity incentive plans, upon vesting of RSUs, if we issue restricted stock to our employees under our equity incentive plans, or if we otherwise issue additional shares of our common stock. For more information, see “Dilution”.

Note the blanks, which makes FB impossible to value on a per share basis, yet.

We’ll have to wait until the final days of the capital raising before we can come up with a firm valuation on a per share basis but for now, the circa $27bln valuation stands.

Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 2 February 2012.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. I know i am a bit late to this party now but i thought i would add the following thought.

    $3.7 billion of revenue and 845 monthly active users (so probably best indicator of total users) means that average revenue per user of $4.38.

    Now Facebook is an advertising company and not a service company so i know that the majority of revenue is not coming from the users but i would argue that it is directly linked as the desire for advertising will increase/decrease depending on the total people using the program.

    Why bother advertising or paying the same rate if there are significantly less people to advertise to?

    I think Facebook acknowledged this when they say that their “users and revenues will decline over time”. A damning statement in itself, however ignoring that, i believe the number of users will act kind of like debt. In good times (high amount of users) the results will be great however in bad times (facebook is not as popular and users significantly decline) than the bad times will be compounded and result in really bad results.

    The question for anyone interested in buying facebook (and i doubt anyone here is), where do you see user numbers going in the future?

  2. I think people need to understand why Facebook is being taken “public” to fully understand why it’s such a shoddy deal for retail investors.

    Zuckerberg and co are basically being forced into it due to their shareholder numbers. They are not really interested in the usual reasons for going public. They really have no real pressing concern, needs, plans, or vision of what to do with the 5 billion.

    The money they raise is essentially just a reward for all the people and corporations who took a punt on them when they were starting up. It’s a way for people already in the company to partially “cash out” and reward their investments. I reckon a few of the venture capitalists involved have been pressing Mark et al to give them a tangible (money) return on their initial investment.

    Mark Zuckerberg has no interest in seeing control of his company vanish. He has no interest and no need. The listing documents clearly outline what a terrible deal it is for the Class A owners. They are upfront about it and they don’t care. They know that someone will buy them. Someone always does. But it will probably be at the lower end of their offer price. If they offer large chunks of available shares to investment banks then it will be a no brainer. These institutions specialise in rewarding long term clients with guaranteed IPO shares at an artificially low entry price. The lure of “stag profits” is a sugary sweet enticement.

    But the underlying reasons as to why this is such a bad deal for retail investors is simply because the company really has no interest at all in working for the betterment of these second rate investors.

    And to be honest, I don’t really blame them. As far as I can tell, they are bring pretty up front as to why they are doing it. If your average Joe still wants to “invest” in them hoping they are the next google, then, well, um, what can I say?

  3. Roger,

    You caught my attention with the second sentence of your opening paragraph. Are you able to share a timeline (excuse the pun) with us?


  4. Craig in Brisbane

    With 100 billion friends, I’ll be popular, not rich. Right up till someone friendlier comes around.

  5. Are you people MAD… $27billion DOLLARS (not rupees or pesos)!!!
    We are talking about a company with very few tangible assets and mediocre IP. I would go so far as to say that FB is not even a legitimate business! Its key driver to success (which the company doesn’t even own) is the “buzz” for FB.
    And this buzz can disappear very quickly… eg Myspace which was bought for the ridiculous sum of ~600M only to be sold for 35M some years later…

    The risks associated with owning a business such as this are extremely high and to attach a valuation of $20B is plain absurd. I would not buy facebook as a standalone business for any more than ~$3B, at a stretch! Not that a business such as this would interest me…

    At $100B you could own WOW, WES, WPL and QBE… which would you prefer???

    • I completley agree Dan, i would not buy facebook at all. My $20B value was a quick calc but the assumptions in that calc i think were very optimistic when looking out to the future.

      I just don’t think it is a good business. There are only so many more people that can join facebook, only so many more ways to grind out a few more advertising dollars, its business is likely to be already quite lean as it is an internet company so cost cutting is likely to be hard to do. I just can’t see where the long term profit growth is going to come from. I can see any acquisitions being done harming the value. This is precisely why i am so interested in this float, i think it is a bad investment but one which is hyped up to such a degree that it appears like a roaring success to begin with.

      I think the money has already been made and that is why they are floating. It wouldn’t surprise me to see some existing (pre-float) equity holders sell a substantial amount of their shares onto the market.

  6. ‘The fact is that a bubble market has allowed the creation of bubble companies, entities designed more with an eye to making money off investors rather than for them’ – Warren Buffett.

    You will experience substantial and immediate dilution! Classic- who in their right mind would buy into a company knowing full well they would be diluted from day one.

    You would hope that the aquisitons they are referring to would not be in the same vein as Geocities or aQuantive.

  7. someone mentioned that Facebooks net profit after tax was $500mil so if that is true a 100billion valuation would be one thing… smoke on the water

    • They netted just over $606 mln for A and B class shareholders last year (to Dec2011) but preferred shares will all be converted this year and they total for ordinary and preferred shareholders was $1bln.

      • Though not uncommon in the US tech scene, it’s worth noting the voting structure of A/B-Class shares:

        Shares issued in the IPO (A-Class) will have 1 voting right each. Zuckerberg and early investors hold B-Class shares – these have 10 voting rights each. Through “voting agreements” Zuckerberg controls 57% of votes. Should any B-Class shareholders sell-out, their shares will automatically convert to A-Class.

      • Here’s an excerpt:

        “Zuckerberg will own only about 28 percent of Facebook post-IPO, but the company will be structured so as to have two classes of stock, Class A shares and Class B shares. Class B shares will each carry 10 times the voting weight of Class A shares. Combine Zuckerberg’s Class B shares with proxies he controls, and he has 57 percent of the voting rights over the company. Splits between two classes of shareholders are fairly common, especially with company’s like Slate’s parent, the Washington Post Company, that are associated with a particular family, but for a single individual to have an absolute majority stake in such a large company is very rare. Even Bill Gates controlled less than 50 percent of Microsoft after its IPO.
        It gets better. When an owner of Class B shares sells his or her shares to someone else, they transform magically into Class A shares. That means that if any other Class B shareholder liquidates any shares, Zuckerberg’s degree of control goes up. But since Zuckerberg personally controls a majority of the votes, there’s no benefit to owning Class B shares at the moment and nobody but he has any particular incentive to hang onto them. This, in turn, means that once Zuckerberg’s partners have partially cashed out, he’ll be able to sell many of his Class B shares without substantially diluting his personal control over the company.
        And Zuckerberg clearly intends to maintain this arrangement for the long haul, as evidenced by Facebook’s unusual proposed governance structure. The normal rules for an American company require that a majority of the members of a firm’s board of directors be “independent,” rather than managers of the firm. They also require the existence of special committees of independent directors to consider executive compensation and the nomination of new directors. But Facebook, as what’s called a “controlled company,” qualifies for exemptions from those rules—exemptions it intends to take advantage of. In particular, Facebook says it won’t have an independent nominating function for its board and states that it reserves the right to eschew independent directors and an independent compensation committee. What’s more, the transmogrification of Class B shares to Class A status has an exemption “for estate planning purposes” and states that “in the event that Mr. Zuckerberg controls our company at the time of his death, control may be transferred to a person or entity that he designates as his successor.”
        To make a long story short, absolutely nothing—up to and including death—is going to dislodge Zuckerberg from control of his firm.”

  8. Good to see i was pretty close (assuming a 26% net margin) with my estimate of profits in my previous post. I did a rather crude valuation upon looking at the information using a variation of the value.able formula and i got $20 billion for 2012 (14% discount rate), no doubt i have missed a few things but i just wanted to have a go.

    As i mentioned before if the 75-100 billion market cap prediction is correct than i think it would be extremley overvalued and everything seems to be agreeing with that hypothesis. It will probably go through the roof upon listing but those people are playing a different game to me, if playing any game at all. It is the perfect stock for people who get excited about “stories”.

    The no dividend line is not surprising, its exactly what i would expect for a company like this. The line about experiencing substantial dilution is a classic, and the lines about declining revenue agrees with my belief that they don’t have much further to grow, at least they are up front about all this stuff.

    I would like to see what acquisitions they are interested in, this sounds like a ticking time bomb to me.

    My gut feeling is that this is a company to stay well away from both in the float and after listing. But it will be a very interesting story to follow. I plan to keep following it as it is a type of company which is “new” and hyped up beyond belief. I will be very interested to see years from now whether Facebook is the giant success story or another Yahoo.

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