Is Facebook worth $100 billion?
February 10, 2012 in Tech News
A hundred billion dollars. That is the number whispered for Facebook’s value after the social networking company has its initial public offering.
But some investment professionals are scoffing, claiming that Facebook is worth less, perhaps only $75 billion or the shockingly smaller $50 billion.
Even if the skeptics are right about Facebook’s true worth, it does not mean that Facebook stock will not trade at a price giving the company that vaunted $100 billion valuation.
The reason: Facebook’s underwriters led by Morgan Stanley are likely to be able to influence the market in Facebook shares to fulfill the buzz and reach that $100 billion number.
How can this be?
Henry Blodget, the former equity research analyst and current editor in chief of Business Insider, wrote an extended post last week about valuing Facebook. Mr. Blodget wrote that Facebook has an “absolutely amazing” business. But Mr. Blodget also concluded that just because Facebook was a fantastic business did not mean it was worth $100 billion. Mr. Blodget noted that if Facebook traded at Google’s 20 times price to earnings, or P/E, a common valuation metric, the company would be worth only $20 billion. Facebook is growing faster than Google, but even applying a higher multiple of 50 times Facebook’s P/E, the company would only be valued at $50 billion. Mr. Blodget concluded that $75 billion was an aggressive valuation for the company.
Of course, many may disagree with Mr. Blodget. Facebook has huge growth potential abroad, including eventual entry into China. The company is also likely to find some way to further monetize its mobile traffic and its user base, possibly by integrating ads into news feeds. Either of these possibilities may justify a valuation higher than Mr. Blodget’s.
As Mr. Blodget notes, Facebook’s true value is not necessarily what people will pay in the market for its stock. The value of Facebook is its intrinsic worth. This is different than Facebook’s stock market value, which is set by the price investors are willing to pay to own Facebook stock. The two may not always be equal and they frequently diverge. Case in point: Remember during the dot-com bubble a decade ago when Pets.com stock traded at a price giving the company a multibillion-dollar valuation? Months later, Pets.com was bankrupt. Pets.com’s true value turned out to be far less than its stock price indicated.
Facebook’s stock price will benefit from the same hype that drove the dot-com bubble, though in fairness to the company it is a much better business than the high-flyers from that time. Last year, Facebook earned more than a billion dollars.
Even beyond the hype that will drive Facebook’s shares up, the deck is stacked toward Facebook trading at a $100 billion value. The reason is that any number below that figure will have some people deeming the I.P.O. a failure.
And Facebook’s I.P.O. underwriters have a strong incentive to ensure that this does not happen. They are no doubt hungry for the reputational benefit of successfully orchestrating the most newsworthy I.P.O. since Google.
The investment banks are very good at this game. As we just witnessed in the Groupon I.P.O., in which only about 5 percent of the company’s stock was sold, one way investment bankers can increase the offering and trading price of an I.P.O. is to sell a small number of shares. Potential investors will then bid up the price pursuing this small float.
Morgan Stanley already appears to be managing Facebook’s offering with this trick in mind. Facebook is preliminarily planning to offer only $5 billion worth of shares, less than the $10 billion offering that was originally considered. Mark Zuckerberg, Facebook’s chief executive and co-founder, is expected to sell about $2 billion worth of Facebook shares to pay his tax bill from exercising his outstanding options in connection with the offering.
This means that Facebook’s offering is near the bare minimum in number and dollars. It appears that less than 10 percent of Facebook’s outstanding shares will be sold in the offering, leaving the bulk of Facebook’s shares in private hands.
This relatively small offering is intended to build demand through simple economics. By limiting supply, built-in demand for Facebook’s shares will raise the price investors pay. Many investors will purchase predicting a huge pop in Facebook’s stock.
The aggregate number of shares that Facebook offers in the I.P.O. will thus be a barometer for how well the offering is going. The underwriters are likely to increase or decrease the number to match demand in a way that creates a huge pop and a share price equaling a $100 billion valuation.
There will be yet another driver pushing Facebook’s stock price to the stratosphere.
During the dot-com bubble, investment banks would spin off I.P.O. shares to top clients and have arrangements to sell shares in the offering to further ensure that there was high demand. These practices were not only controversial but in some cases illegal. They are now forbidden by law or internal investment banking policies.
These prohibitions do not stop the underwriter’s clients from informally purchasing Facebook shares to ensure that the banks will offer them the next hot I.P.O. In other words, Morgan Stanley and the remainder of the underwriting investment banks in this offering will already have built-in demand. Their premium clients will soak up most of the shares, leaving even fewer shares for the public and pushing them to buy in the I.P.O. after-market, further pushing up Facebook’s price. This is likely to be a big driver of Facebook’s post-I.P.O. stock price as there is tremendous interest among retail investors in owning a piece of Facebook. Indeed, many hedge funds and institutional investors interested in Facebook have already bought shares on the private markets.
The end result is that the Facebook offering is likely to value the company at $100 billion, not because Facebook is worth that figure, but because of the mechanics of I.P.O.’s. But Facebook may not stay at a $100 billion valuation forever if it is not truly worth that amount. In the long run, stock prices tend to revert back to fundamental value as the market realizes its mistakes. We have learned that lesson repeatedly over the last decade.