Why Did the Facebook IPO Failed so Hard?

This post aims at showing you how you can perform a simple financial evaluation of an investment possibility to decide if it may or may not be a suitable opportunity. This is not a full analysis, it is just a financial analysis, that does not take into account the company strategy or other intangibles. The goal here is just to determine whether the price was, at first glance, a fair one.

First of all I believe we can already say that the Facebook IPO was a fail in the investors’ perspective. If you’ve lost 37% in a couple weeks since the IPO then I think it is fair to call it a big fail. But why did it happen, and most of all, how could we have avoided it?

I’ll explain my rationale in this post. In my books I always go around comparing companies inside the same strategic group, or industry which means that it is always possible to get a measure of value by comparison with other companies.

For the Facebook IPO, I did the same, the biggest difference was that I only used 1 reference: the Google IPO. FB and Goog are in the same strategic group, the scale of the operation was similar and their IPO was pretty similar which justifies my decision to use Google as comparison term.

So let’s look at the facts. Google went public in 2004 at around USD 85, they had profits of USD 1.46 per share in 2004, and therefore a Price to Earnings Ratio (PER) of 58 which means that you needed 58 years of profits to get back your initial investment (assuming no growth in profits and if the company distributed 100% of the profits as dividends). They also had around USD 3.189 Billion in revenues.

What about Facebook? Well FB went public at USD 38, with profits around USD 0.31 per share, which means a PER of 122 (doubling Google’s PER at the IPO). Their revenues were around USD 3.711 Billion.

What can we conclude from here? Well the PER can be a measure of perspectives, a big PER might mean that the markets expects the company to grow fast, a low PER might mean that the market expects the company to sink. With a PER of 58 investors were expecting a lot from Google’s future, but with a PER of 122, investors were expecting even more from FB.

Were expectations realistic? The answer was set by Google. In 2005 Google doubled its revenues to USD 6.138 Billion, and its Earnings per Share (EPS) grew to USD 5.02, shrinking the IPO initial PER to a realistic 17. Could FB keep up to this marvelous performance? To do that they needed to double its revenues, and grew it EPS from USD 0.31 to something around USD 2.24.

So the answer is no way! Just by looking at the last quarter results before the IPO you would see that the year over year growth in revenues was far from doubling, the same goes for the EPS. If you had searched a little bit in the news, you would have read about the difficulties that FB was having with its publicity revenues, no way they could top Google’s performance.
So at USD 38 you were paying too much.

However the market does not forgive mistakes like this one, and the real winners from this were the investment bankers… as usual.


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