Is Facebook Really Worth $42.37 Billion?

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A total of $42.37 billion. That's the implied valuation ascribed to shares of Facebook on secondary share offering site Sharespost. That puts the company somewhere between Morgan Stanley (NYSE: MS  ) and Target (NYSE: TGT  ) in terms of equity value in this country. Simply incredible.  

Is the company really worth that much?

The dawn of an empire
I joined Facebook back in 2004-2005 when it was essentially a place where a few hundred thousand college students could evaluate the looks of their classmates, trade photos of the prior night's antics, and organize a last-minute party or two. In the ensuing years that witnessed Facebook's rise to prominence, the company performed admirably well in all of these tasks and more, so well in fact that the rest is history. With more than 500 million users today, the company dwarfs all but two nations in terms of population.

The problem in my view is that popularity doesn't necessarily translate over to profitability -- at least, profitability on the scale that would be necessary to support a massive valuation like this one. This is especially important considering the fact that we seem to be inching toward an inevitable Facebook IPO.

What is it worth?
There's no doubt that Facebook has turned into a beast unto itself, supporting a variety of cottage industry and even unique platforms of its own. But, what is interesting is the incredible hype that continues to surround a business that has still not yet found a meaningful road to monetization for itself. Call me ignorant, but all I see for the time being is a relatively unproven business model, pushing an extraordinary valuation.

Consider a few figures. The Economic Times estimated Facebook's 2009 revenue at $800 million and estimated that the company brought in "a solid net profit in the tens of millions" -- not bad at all for a fast-growing Internet company. However, reflect on these figures against that $42 billion valuation and all of a sudden that $800 in revenue looks fairly miniscule. Even if these estimates are off by a factor of ten (Fortune pegs them even lower, by the way), Facebook would still be priced outrageously high.

I'm no Benjamin Graham, but even I can see that shares of Facebook today are trading for, ohhh, about 50 times sales and at least 1,000 times earnings. To put that number in perspective, the two highest going price-to-sales multiples of companies over the $25 billion threshold today are (Nasdaq: BIDU  ) and VMWare (NYSE: VMW  ) , which chime in at 34 times and 13 times, respectively. The only difference is that Baidu already pulls in about $420 million in earnings after only barely denting its Chinese market with a very proven business model, while VMware delivers about $300 million on top of a proven model of its own.

Big money flowing
It's not just the relative valuation that is fascinating to look at here -- it's the scale we're dealing with. As I mentioned earlier, right now Facebook's equity capital is worth about what Morgan Stanley and Target are worth individually. But consider for a moment the profitability of these two companies. Morgan brought in about $4.5 billion in earnings in the past 12 months, while Target brought in about $2.8 billion. Facebook would have to go from earning in the "tens of millions" to the multiple billions to at least substantiate its existing valuation. It's definitely possible to hit this hurdle, but there are admittedly few companies in the world that have ever made that kind of leap successfully and sustainably. It's not easy.

Considering the scale on which Facebook works, CEO Mark Zuckerberg could probably slap on a $25 fee per user and leapfrog over both Morgan Stanley and Target in the short term and start hauling in some serious loot.

But, herein lies the problem. How exactly will Facebook monetize itself when it finally decides to do so on a massive level? Can it even monetize without voiding its own existence?

Svetlana Kjerxacndsky has indicated you are a friend
There was a time when I really enjoyed Facebook and all of its features. These days, however, I'm pretty much already friends with everyone I could plausibly call a friend. All those irregular hits of joy from friend requests and pokes and whatnot have been eclipsed by many larger instances of displeasure thanks to phony invites from what appear to be either mail-order brides or scam artists or both. For someone who's been in the system for a few years now, the initial thrill is definitely gone, and the platform is now beginning to lose serious appeal. One should ask whether the majority of users can see long-term value in this company.

More significant is the fact that Facebook is less of a service and more of a novelty. If faced with the proposition of paying for Facebook, I would balk -- hard and fast. Of course, Facebook doesn't make money via subscription (and probably couldn't even if it wanted to). Instead, Facebook makes money via targeted advertising and a few other hard-to-define products.

Facebook doesn't really offer me any kind of core service that would force me to work through its still very immature ad engine. Google (Nasdaq: GOOG  ) already has that on lock-down with its search, email, and other features.

In other words, if I had to choose between the two, Facebook would be gone in a second. Plus, Google is churning such a massive amount of cash flow today that it has a nearly unlimited tap to hit for capital to develop the products of tomorrow. I just don't see how Facebook can make that oh-so-critical transition from user behemoth of today to profit machine of tomorrow.

The Facebook bottom line
I don't claim to know or understand everything that Facebook is doing to substantiate its outrageously high valuation. All I know is that based on my own experiences with the business, the numbers indicate to me that the company is unlikely to match up the lofty expectations of its investors. It's possible, yeah, but improbable.

I like the company and admire its meteoric rise to power. But if you're looking at the company as a future investor, take some time to think about how the company will reward you. I'm not sure the company even knows yet for itself.

Fool Nick Kapur thought Facebook died the day his parents joined. He owns no shares of any company mentioned above. Google is a Motley Fool Inside Value pick. Baidu, Google, and VMware are Motley Fool Rule Breakers recommendations. The Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 29, 2010, at 8:38 PM, SeekTheFire wrote:

    I am intrigued by Facebook. The Time Person of the Article was great if you didn't check it out. I agree with the author that how it meets its huge potential valuation is not clear to me. I like Facebook and its free. I'm not sure if I would pay for it. I teach teens and I'm pretty sure they wouldn't pay for it since they firmly believe everything on the internet should be free.

    I must admit that Zuckerberg and Facebook have a compelling vision for connecting people that I love. What has not been articulated is a compelling business model. Anyone have an inspiring investment thesis for a Facebook IPO?

  • Report this Comment On December 30, 2010, at 11:28 AM, EquityBull wrote:

    I agree with the author as well. FaceBook is way overvalued here. They have what I like to call "junk traffic". That is page views that do not monetize well. I have founded and run many internet communities and know firsthand you see big differences in the types of traffic a site will receive and the value of said traffic.

    The type of traffic facebook gets is not a high yielding type of traffic in terms of ad revenue. I think for Facebook to get a viable model to justify such valuation they have to start charging gaming companies to exist on their platform and other ancillary revenue methodologies. Relying on low value ad traffic won't cut it.

    Also the model is assailable by competitors. They did it to myspace and who might do it to them next?

    Almost everyone I know starts hot and heavy on facebook but then the shine wears off and they visit it a small fraction of what they used to. I myself only check it once a month if that these days. My wife was several times daily and now also once every couple weeks. Once you find your long lost friends and get over the newness of FB it is nothing with legs. I would be surprised if they were not the next AOL in a decade

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