Posted: Feb 12, 2012

Facebook IPO valuation - is it justified?

Facebook has recently filed for its IPO. Ticker: FB.

The social networking giant expects to raise $5 Billion through the IPO. Since the company would only be offering a part of the total shares for the IPO, the net valuation for the company is expected to be around $100 Billion. That is, when Facebook begins trading, it's market cap is expected to be $100 Billion.

First, if all of this works out, it will by far be one of the biggest IPO's that the planet has ever seen. With this market cap, Facebook will stand quite close to another kind of networking giant - Cisco - whose market cap is just above $100B at the time of writing. Facebook generated around $4 Billion in revenue last year and booked profits of around $700 Million. That's nothing to scoff at for a company filing for IPO. Most companies just have sales to show the investors - no profits. In comparison, Cisco the internet giant did $43 Billion in revenue and $9 Billion in profits. That's more than 10x that of Facebook.

This indicates that Facebook is expected to see much more growth in the years ahead. Compared to Cisco that's a 25+ year old company, Facebook is still in it's infancy - at 8 years old. During this time, it has already fought off a major competitor - MySpace. It's currently experiencing stiff competition from Google - Google+. Almost everyone I know already has a Facebook account. Some of my friends already moved to Google+ not because it's better than Facebook, but mainly because of the privacy issues at Facebook. In it's quest to gain more and more members, Facebook tried to make more of existing members' data available to public, so that it's easier for someone to distinguish between Tom Jones from Bakersville NC and his namesake from Silver Creek OH. At one time, social forums were filled with "I closed my Facebook account today... Me too... Me too..." kind of messages, because members didn't like Facebook exposing their data without their permission. Facebook is facing some challenges.

Like several other things, social networking is probably a short term phenomenon that will lose it's lustre over time. That said, Facebook can hold a lionshare of this market if it keeps innovating. Usually, only young people can think and act like young people. Just wait till Mark Zuckerberg turns 30 in a couple of years! I didn't mean to say that Facebook is just for young people, but a good share of Facebook users are. Like getting online was the big thing at the turn of the millenium, getting social has been a big thing in recent times, but just like the online players saturated in a decade, the social players would also plateau out. Facebook is already 8 years old, that leaves a few years to saturation.

My take on Facebook IPO - if it opens on a good day for the market, it could shoot up maybe 15-30%, then languish there for a while before traveling back to earth. Groupon and LinkedIn are some examples from the recent past that are below their IPO day closing prices at this time. Facebook is very likely to follow their path. If you are nimble enough to trade Facebook, and if you have some cash that you are OK with losing completely, go for it. Otherwise, just stay on the fence and watch while the fun unfolds.

If you have the guts, go for put options on the stock when those become available. Buy some puts through OptionsHouse, when you see the media filled with all praise for Facebook because that's usually when put options would be the cheapest as everyone would be clamoring to get into the stock.

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