Everybody is excited about the upcoming IPO of Facebook. It is touted as a beacon of economic recovery, free enterprise and all those things by the media. But I consider it as one of the biggest con jobs in the history of capitalism. Everybody loves Facebook nowadays and anyone who says anything bad about it is considered evil and flamed. Before you jump to your conclusions, take a moment to read this article.
What is Facebook worth? Around 100 Billion dollars
And why is that? Because Goldman Sachs says so.
With the advent of modern day capitalism, we rely on experts to tell us the value of new things that just came into being and which we do not understand fully. People don’t understand the business of Facebook fully but just vow that Facebook is cool. So Facebook self-proclaims its value to be 100B USD citing a bunch of hip reasons and who certifies it? Goldman Sachs and its brothers – The usual suspects!! Their track record has been to do any business that makes them the Money.
Why do I think this is exaggerated?
Let’s us look at some numbers. Numbers don’t lie. Facebook made around 2B in revenue and 1B in profit last year. What does that mean? Banks in India give you an Interest of around 10% and you can buy secured corporate debt yielding more than 15% from the open market. This means if you do invest in any business, you are expecting to get a higher return than this. Any business is risky and can fail. You are supposed to take the risk only if you get appropriate returns. This is measured by the term PE ration in the world of finance. PE stands for Price over Earnings. If your bank is giving you 10% interest, it means a Deposit certificate priced Rs.100 will earn you Rs.10. That makes the PE ratio 10. What common sense tells you is that any business more risky than the government backed bank should not have a PE ratio more than 10. Now if Facebook’s worth is 100B and Earnings 1B its PE ratio becomes 100. Now compare this with some of its peers in the Tech Vertical – Microsoft 11.4, Google 21.26, IBM 15.7, Intel 11.7 and Apple 18. Observe that all these companies have PE ratios higher than 10. Why do people still invest in these stocks if they get more returns from a bank? The answer is ‘Growth’. Investors are speculating that the companies will grow and then their capital will appreciate.
But now for Facebook to grow its income from 1B to 10 B how long will it take? Google currently has earnings of 9.7B and it took 7 years to get there from 1B. There are only 37 companies in the world which have earning greater than 10 Billion dollars. 11 of them are oil companies and only 4 of them are Tech companies. There is only so much money in advertising and the existing players are not all sitting ducks.
Now let us look at the costs.
When I last looked at the big datacenters that these companies run, Facebook had 800,000 computers, Google had 600,000 and Microsoft just 350,000. Facebook is just a one trick pony – that just does one thing beautifully – that is Social Networking. Google does that and also so many other things such as search, email, maps and so on. Microsoft even provides virtual labs where huge communities of developers get trained to use its technologies for free. And yet all these companies need fewer computers than Facebook – which means the costs for Facebook are much higher. Facebook attributes it to the higher level of engagement of its users – but does that higher level of engagement proportionally add to its revenue?
Why does Facebook need that much money?
IPO is a capital raising activity. An institution raises capital if it needs funds to expand or change ownership pattern. If you still think that Facebook has not saturated and needs money to build new datacenters how much money would it need? Say it wants to buy an additional 1M computers. These are blades racked up and might cost around $500 a pop. Assuming another $500 goes towards the cost of feeding it and maintaining it in a controlled environment, it would still cost only 1B dollars. Then why the hell is it raising 10B dollars? To pay taxes that is what they said. You pay taxes when you book your profits. So Mark Zuckerberg and his friends plan to cash in part of their stakes in the company for real money and pay taxes. Given that the price of the company is already overestimated, the existing owners want to pass on their assets to new owners. The new owners will be either short term traders who keep on passing the buck or retail investors who do not understand finances. I agree that Mark is a smart guy and has worked hard to build the company but should all investors hand over their money to make him rich and an icon of capitalism. Right now what he has is money on paper and that will become useful only when somebody converts that into really money and the IPO is a legal front for this money laundering.
Why will the IPO succeed?
Of course it will. Here are my reasons.
- Doesn’t anyone understand finances enough to see through this? Facebook sold a part of their stake to some 500 early investors a few years ago. Now these are handpicked individuals and intuitions that represent the smart money. They too bought their stakes at an inflated price but now they will sell it to new entrants at a much higher price. Since these are the market makers, they will make sure that the IPO goes through fine as their success depends on it. They will work the media, analysts and the entire capitalist system for you.
- Isn’t there some authority to look into such schemes? The regulators and legislators are the friends of these 500 early investors and will not look into places where they should not be looking into. Further the government is getting some free tax revenue. So again it is in its best interest that this goes through. Further it will take credit that such a wonderful big thing happened during its regime.
- Why will investors hand over all their Money? In the end it will be just the retail investors who will bear the losses. Goldman is sitting with its super computers ready. It will make sure that the stock won’t tank immediately. Until the smart money has moved out and Mark and his friends have booked in their profits they will make sure that the stock will hold steady and may even rise. This will lure in more and more retail investors because. Even those who do read into these numbers will see that the price is holding and that will validate the initial valuations and give in to temptation. Who doesn’t want to have a piece of Facebook? There will also be a few more glowing quarters with decent growth and that will attract more investors. Then when the business saturates, Goldman’s computers will play other games. Facebook will stay flat for years if not go down. Somehow people do not seem to learn from the .com bubble. Companies like Corning, Yahoo, JDSU, Akamai which all looked invincible at that time have never reached their hay day valuations. Zuckerberg will not be able to offload his entire 28% stake in the company anytime soon, but he will surely find a Sucker Bird from the retail pool to finance his lavish lifestyle and validate his net worth by tricking him to buy a small piece of the company at an inflated price.
Note: The numbers used in this article are all approximations and mostly from memory. If you have accurate values with references, I will be happy to edit the article and may be even change my opinion.