Wednesday, February 1, 2012

Facebook Drops Its Drawers - Is Zuckerberg Hung?

Facebook finally releases its IPO data. 
Is it making money?  Nowadays.
 Is is a good buy?  Not really.

The Facebook prospectus is available online here.  At first blush, it might appear to some readers that this company is doing well.   They provide income data for the last eight quarters:

Three Months Ended
  Mar 31,
  Jun 30,
  Sep 30,
  Dec 31,
  Mar 31,
  Jun 30,
  Sep 30,
  Dec 31,
  (in millions)
Consolidated Statements of Income Data:
Advertising revenue
  $  340    $  424    $  450    $  655    $  637    $  776    $  798    $943  
Payments and other fees revenue
  5    8    17    76    94    119    156    188  








Total revenue
  345    431    467    731    731    895    954    1,131  
Costs and expenses(1):
Cost of revenue
  100    111    131    150    167    210    236    247  
Marketing and sales
  36    44    45    59    68    103    124    132  
Research and development
  25    32    41    45    57    99    108    124  
General and administrative
  22    26    34    40    51    76    72    80  








Total costs and expenses
  183    213    251    294    343    488    540    583  








Income from operations
  162    218    216    437    388    407    414    548  








Net income
  $95    $129    $131    $251    $233    $240    $227    $302  








From this chart, you can see that income has risen steadily since 2010.  No data is provided before then.  From what I read on the net, and if you connect the dots on this chart, there was no income before then, but a slight loss.

Note also the staggering increase in advertising revenue.  Given that Facebook's membership has been pretty flat for the last two years (it certainly hasn't grown by a factor of three), these are puzzling numbers.  Why has ad revenue increased?  Are they charging more, or putting more ads in, or what?

So they are finally making money, right?  This has to be a good bet - a money-making dot com stock!  And a 27% profit - not bad, right?

Hold your horses, Nelly, look again.  With $302 million in revenue for the last quarter, we are looking at a Billion a year in profit (income).  Not bad.  But does that make the company worth $100 Billion?  If so, the P/E ratio would be 100 - meaning if you bought this stock, it would take 100 years to earn back your investment - assuming revenues continue to hold.

And yes, a 100 P/E ratio is considered pretty high.  Apple's is about 13.  Google's is about 20.

Granted, it is better than LinkedIn, which has a P/E ratio of nearly 600 (yikes) or Groupon which has a P/E ratio of [divide by zero error] as it has no "E" (earnings) in its ratio, just "P" (price).

A 27% profit ratio sounds pretty sweet, compared to some traditional manufacturing industries - where profit margins are often razor slim.  On the other hand, for a company with little or no overhead, other than servers, office leases, and salaries, well, it is surprising it took them this long to make money and that the profit margin is so low.

But what about other factors?  You see, Facebook does have some debt, which is the other side of any company's books:

1 Year
5  Years
Operating lease obligations
  $945    $   180    $   243    $   197    $   325  
Capital lease obligations
  817    322    337    28    130  
Other contractual commitments(1)
  500    450    25    25      





Total contractual obligations
  $2,262    $952    $605    $250    $455  


So, Facebook has about $2 Billion in debt to pay off.   No doubt, floating $5 Billion in stock will pay this off.

What about assets?  Dot Com companies generally don't have much - some servers, leased office space, a bunch of rapidly depreciating desktop workstations.

Current assets:
Cash and cash equivalents
  $1,785  $1,512  $1,512  
Marketable securities
    2,396  2,396  
Accounts receivable, net of allowances for doubtful accounts of $11 and $17 as of December 31, 2010 and 2011, respectively
  373  547  547  
Prepaid expenses and other current assets
  88  149  478  

Total current assets
  2,246  4,604  4,933  
Property and equipment, net
  574  1,475  1,475  
Goodwill and intangible assets, net
  96  162  162  
Other assets
  74  90  90  

Total assets
  $2,990  $6,331  $6,660  

This part of the balance sheet shows the cash infusion from investors recently.  The company claims to have about $6 Billion in assets (I would not count goodwill and intangibles for much).  So the liquidation value of the company is 5 cents on the dollar - actually about 3 cents, if you subtract the debt obligations.  Again, not unusual for a dot-com company.

In order for Facebook to be valued at the vaunted $100 Billion, its income would have to increase by a factor of 5 or so.  And perhaps that is one reason why Facebook is toning down expectations and valuation, to closer to $75 Billion - still astronomically high, but not as radical as $100 Billion.

And Facebook now says it may offer only $5 Billion in stock.  Why is this?  Well to understand, you have to understand how the IPO game is played.

When they sell the IPO stock, you can't buy it at the IPO price.  All the shares are "subscribed" to friends of the big investment banks (those 1%'ers you read about lately) and they quickly turn around and sell the shares for more money, to chumps like you and me.

Why would the founders do this, you say?  It makes no sense on its face - the company sells the stock at one price, and middlemen jack up the price and make money.  The company doesn't get full value for its stock.

But you see, by hyping the stock this way - by creating an artificial shortage, the founders hope to drive up the price, so when they sell their shares (after the lockup period) they will make a mint.

But $10 Billion was apparently more than the subscribers could swallow.  You see, if not enough people subscribe, and the stock doesn't sell out, then no one in the secondary market will pay more than the IPO price, and the subscribers lose money.  Boo-freaking-hoo for them!

So they downgraded the offering to $5 Billion.  Again, they care less about the offering that what they, as founders of the company (or existing shareholders) can get, once they can hype the stock price up on the New York Exchange.  So you sell a measly piece of the company, create hype, and cash out.  Pretty sweet deal for them.

Not for you, though.

Facebook doesn't need the money - they have enough cash-on-hand and earnings to pay the bills and not a lot of debt to pay off - only 5-6 times annual earnings.  What they need is a marketable security that can be sold on the NYSE so the people who founded the company can cash out their investment.  That is the name of the game for IPOs.

What?  You thought they were doing this to "raise capital?"  If they needed $5 Billion, they have friends who could write them a check.  You thought they were doing this out of the goodness of their heart to let you, Joe Littleguy, get in on the action?  Don't be so naive.

What is likely to happen is that when the stock is offered, there will be hype and hoopla (thank you Media, for in-depth reporting!  Not!) and chumpsters by the millions will "invest" in Facebook, giving their broker blubbering thanks for paying only $10 over the IPO price.  The stock will spike for a little while, then tank (once the founders start quietly selling), leaving Joe Small Investor once again holding the bag.

But what about the bottom line - profits per share?  If the company is earning a Billion a year, and is worth $100 Billion, that is returning 1 penny on the dollar invested.  From the prospectus is this curious entry:

Earnings per share attributable to Class A and Class B common stockholders:
  $0.12  $0.34  $0.52  

  $0.10  $0.28  $0.46  

This would seem to suggest a share price of $50 or so, at the $100 Billion valuation, perhaps $35 a share at the $75 Billion valuation.

Will Facebook make money? Perhaps.  Will the founders make money?  Bet on it.  Will Facebook continue to make money in perpetuity?  Maybe, or maybe it will fizzle out.  Is it a good stock buy?  Not at the current earnings ratio.  And these IPO deals are generally a raw deal for Joe Consumer.

If you buy this stock, you have to hope that Facebook's revenues grow by a factor of at least five, in order to get even a 5% rate of return.   Given that their growth rate has plateaued (they now claim to have nearly a billion users) one wonders how revenue can grow to five times the level today, in order to rationalize the stock price.

Or you have to hope that some "bigger fool that you" will pay a lot for the stock because, well, I am not sure why someone would bid this beyond an initial P/E of 100.

Remember, it was Joe Consumer who got creamed last time around, during the dot-com bubble of 1995, when ordinary people bought inflated IPO stocks and then lost their shirts.  I had friends back then, who were sure they were going to be Silicon Valley Millionaires - and leveraged themselves with derivatives, using credit cards to fund it all.   It all went horribly wrong, as the IPO prices soared, and then tanked.

My take on this?  Zuckerberg has a pencil-dick.