The new Facebook valuation has everyone, techie or non-techie, talking about the new media bubble. $50 billion for the social media website with 500 million users, that’s approximately $100 per user. Moreover, this doesn’t include the £1.5billion fund that Goldman is raising from private individuals to invest purely in Facebook. The latest news leads to three questions:
What are their sources of revenue?
The media is by and large comparing Facebook purely to Google in terms of revenue flows i.e. advertising. In this comparison, there may be reason to believe that Facebook cannot have as strong a hold over ad revenues as Google. Why? Google, in a lot of cases, serves as the search engine prior to commercial transactions. There is a higher potential to serve relevant ads. Facebook on the other hand is purely a social platform for a majority of its users.
However in this approach we are ignoring several of the current and future revenue streams which are extremely relevant in Facebook’s environment. This includes Gaming, Facebook credits, Facebook places – all of these may be a small part of the pie currently but they have a significant growth potential. We’ve seen the growth of child portals like Mochi Monsters. Once Facebook gets its privacy concerns addressed, that may be another revenue opportunity (yes, I know, that’s a long time coming but it is an opportunity) Shopping portals, exchange portals, classifieds...the list is endless.
As long as Facebook acts as the platform with a revenue share model and allows developers to let their imaginations go wild with potential uses, all I see is Zuckerberg go ‘KA-CHING!’
Is the valuation really a bubble?
Let’s take a look at the Google IPO way back in 2004. Markets were recovering from the tech bubble and 9/11 when Google started their novel auction based IPO process and the firm settled on a post IPO valuation of $27 billion. The stock had floated at $85 but then finally settled at $100 per share.
In their SEC filing, Google reported revenues of $961.9 million in 2003 (28x) and net profit of $106.5 million (254x). They had been profitable since 2001. As for growth, their revenues had grown at 177% and earnings at 6% since the previous year.
Now let’s take a look at Facebook revenue estimates. They have ranged from $700 million in 2009 to $1.1 billion in June 2010 to $2 billion in Dec 2010. At $2 billion revenues, the valuation is in the Google Price/Revenue range with hardly any illiquidity discount. With an assumption of 15% net margin, we have a P/E of 166x!
Another reference point would be another private firm Zynga. Zynga’s focus is on virtual games and their market is strongly linked to Facebook. Zynga has 237 million MAU users, 67 million active users per day and Second Market transactions estimate their market cap at $2.8 billion. Zynga revenues are estimated at $500 million in 2010. That implies a Price/Revenue ratio of 5.6x (compared to Facebook’s 25x) and a Price/ MAU ratio of 12x (compared to Facebook’s 100x)
In spite of the multiple revenue streams, it does seem like a bubble, doesn’t it?
And yet, if the Facebook valuation had been from Second Market, I would have taken it with a pinch of salt. After all the number would be from investors who have no access to the actual financials of Facebook. But the valuation of $50 billion is from seasoned investors with access to the books.
So why do we still refer to it as a bubble? because the valuation may not be dependent purely on current revenue and future growth potential. DST’s investment could be related to term sheet pay to play terms to maintain their investment level. Goldman wanting to participate in the investment round makes sense to ensure they are the banker of choice when it comes to the IPO and to drum up market interest.
And that brings us to the third question which is linked to the Goldman $1.5 billion Facebook fund or rather the special purpose vehicle.
Is there reason for the SEC to probe the private secondary markets and the Goldman fund – are they a means to evade regulation?
Referring back to the Google IPO again, their bankers were Morgan Stanley and Credit Suisse First Boston. Goldman won’t let that happen again and the current investment and the new fund being raised are clearly insurance measures for the same.
However is it legal? It's hardly surprising any more to have Facebook news which seems under the bar of business fair play be it in their origins, privacy issues, use of subscriber data and now the IPO. Well, we can rest assured that the million dollar lawyers will do their jobs and ensure that the terms are in line with the word of the law. But it is certainly an unhealthy precedent. I had covered the trend is a previous article as Securitization 2.0 (http://www.seedcatalyst.com/joomla/new-developments/innovation-bringing-technology-and-finance-together). At this stage it is a few HNI making the investment. The issue being quoted currently is 'why should only the rich few have the opportunity to invest in firms'. The bigger trouble would start when we have several funds or SPVs being raised for private investments and then traded where no one has an idea of the actual valuation of the investments (sound like CDOs to anyone).
‘Big deal about selling more iPhones than last quarter is that holiday quarter normally has 1.5 times the sales of any other quarter. Also traditionally, 2nd quarter has no product launches to boost sales and sales are expected to be sluggish as consumers wait for imminent product refreshes in summer. If you look at seasonality of AAPL financials, you'll see this in order of best to worse. Q1: holidays/Xmas Q3: traditional iPhone product refresh cycle & back to school Q4: traditional iPod and Mac product refresh cycles Q2: for above reasons Hence the reason for celebration.. Cheers!!’
So, the points he made were:
1. Apple did better than the last quarter which was the holiday quarter and hence the results are note-worthy
2. The second quarter is generally sluggish and hence the results are note-worthy
While this would typically be true, my questioning the share price was exactly because the data didn’t support these assertions.
On better results vis-a-vis the last quarter: net sales actually dropped 14% from the previous quarter. Net income was down 9%
Quarter on quarter growth
2007
2008
2009
2010
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Net sales
-26%
3%
25%
42%
-22%
-1%
73%
-8%
-24%
-8%
63%
15%
-14%
Cost of sales
-30%
0%
38%
34%
-20%
-3%
67%
-9%
-26%
-3%
42%
23%
-15%
Gross margin
-17%
8%
5%
60%
-26%
5%
84%
-6%
-20%
-17%
101%
6%
-12%
Total OPEX
-4%
11%
8%
17%
-4%
4%
7%
8%
-7%
4%
5%
19%
-2%
Operating income
-25%
6%
2%
101%
-38%
6%
151%
-11%
-25%
-28%
178%
2%
-16%
Net income
-23%
6%
10%
75%
-34%
3%
126%
-7%
-28%
-24%
155%
8%
-9%
On the second point, i.e the second quarter being the sluggish quarter, we are talking about a year when the 3GS has been launched and Apple has entered several new Asian markets. The positive news, I think, should have been expected. Moreover, we had similar results when they launched the iPhone in the US in 2007. A cut of the data I’ve been using as reference:
Y-o-Y Quarter growth
2008
2009
2010
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Net sales
35%
43%
38%
90%
24%
21%
12%
5%
32%
49%
Cost of sales
28%
48%
42%
73%
17%
8%
9%
-7%
26%
44%
Gross margin
50%
34%
30%
129%
35%
47%
16%
27%
42%
55%
Total OPEX
34%
34%
27%
26%
17%
13%
12%
10%
20%
26%
Operating income
61%
33%
34%
230%
46%
77%
20%
33%
52%
71%
Net income
57%
36%
31%
168%
43%
55%
15%
29%
50%
90%
In fact a few analysts have actually commented that Apple seems to underball their figures and then over-deliver for greater impact.
Before, it seems like I am not giving due respect to the master of the day, let me reiterate that as per me the 90% growth in net income is by no means a small feat!!
This is further amplified looking at the performance of their competitors. For example Nokia’s results show their quarter on quarter revenue growth is a mere 3% with gross margin growing at 6%. Removing the impact of NSN – the devices and services division still grew only by 8% - no comparison whatsoever. Yes, I know they have a far greater denominator but still come on.....
Note: Apple's financial year is October to September i.e. Q1 is October to December
Attended an interesting Techcrunch event today – both for investing as well as entrepreneurial perspectives.
Nothing earth-shattering but a host of good presentations and from-the-heart advice from entrepreneurs.
One presentation that I really liked was Ewan from Mobile Industry Review. He very vociferously tried to put the Apple hype in perspective. I’ve been saying it for the last 12 months but then who listens to me.....Apple is all about Steve Jobs and American Coke style marketing (and the touch screen of course J).
Ewan’s Gartner slide on smartphone market share in Feb 2010 was very eye-catching. The general understanding (without data) is that while Nokia is a handset market leader, Apple is very soon going to be the market leader in the smartphone segment. However according to Gartner, the iPhone is only 14% of the market while Symbian is 47%!
This is becoming an almost regular discussion in the Barua residence – are Chinese valuations at bubble levels? Finally, instead of quoting from various newspaper articles and gut feel, I decided to actually take the time out and do a very basic valuation.
This article is slightly divergent from the regular trend of my articles but the impact of China - positive or negative – is felt and will continue to be felt by any and every industry – tech included.
I picked up on the Shanghai Composite for a first look rather than the Hang Seng as being more broadly representative of the Chinese market.
The first thing to look at is the market valuation, the P/E multiple and then, what is the growth that this multiple implies. The Shanghai Composite 52 week range has been 2,274.9 to 3,478.01. The current index value of 3074.576 is at 88% of these highs. However it is at 50% of the market high of 6124 on October 16th, 2007. To put that in context, the S&P 500 is currently trading at 1165.8 which is at 76% of its highs of 1530.2 from May 31st 2007.
Now to traditional valuation.
Step 1: The P/E multiple
Quoting data from the Bespoke Investment Group, the trailing P/E multiple for China is 12x. This in comparison to India at 9x trailing earnings, Brazil 9-10x trailing and Russia at 2.5x.
Step 2: The cost of capital for Chinese equity
Risk free rate: The risk free rate that I’m using is the 10 year US government bond yield plus the difference in inflation between the two countries. The 10 year bond is at 3.663%. US inflation according to the Feb BLS numbers is at 2.1% while Chinese inflation hit its highest level in Feb at 2.7% (Note: this is a significant growth considering that inflation from the IMF October 2009 world economic outlook for China was 1.9%). So now we have our Rf at 3.663% + 0.6% which is 4.263%
Beta: I am taking a bit of a short-cut for beta. The beta of the iShares FTSE/Xinhua China 25 Index Fund vs the S&P 500 is at 1.3. For want of a better data supply for the moment, I am rounding off to a beta of 1.5.
Market risk premium: The industry standard for a long term market risk premium is between 4.5-5.5%. Let’s stay mid-way – 5%.
And that brings us to a cost of capital(r) of 4.263+1.5*(5) which is 11.763%. Putting that in our standard valuation formula of P/E = 1/(r-g), we have an implied growth of 3.4%. To include a range, I’d also like to consider the P/E multiple of the iShares FTSE/Xinhua China 25 Index Fund which is 22x leading to an implied growth of 7.2%.
Moving on to the next point on our list - IPOs of PE portfolio companies. Most of the cancellations we have seen have been the levered PE held firms – Travelport, Merlin Entertainment, New Look – which were looking at >1 billion flotations.
At the same time, there are planned IPOs of firms which have been able to demonstrate a growth story and the ability to continue with the growth. For starters, there is the Apax portfolio firm Promethean, a maker of interactive white boards. According to the FT, the firm is looking at an IPO of £400 million which will value it at 18 times last year’s EBITDA. The firm has no debt and has shown growth of close to 60% over previous year’s profits. A few other floats expected are Emis and the Supergroup. Emis is a £50 million AIM listing for a firm with a turnover of £58 million last year and an operating profit of £15.8 million. Fortinet had a stellar IPO last year but then the firm was a market leader in the UTM space.
As of now, I haven’t come across any venture capital IPO exits but can only hope that VCs are also in discussions with bankers for some of their larger and more stable investments. The Amadeus investment, Icera, comes to mind.
But across the pond it’s a completely different story. There is a spate of VC exits and not all of them seem like the high growth or positive net income stories mentioned above. For some, forget growth, their target markets are themselves in such a flux that you can’t help but wonder what the impact on the firm will be (case in point – TeleNav, Motricity). Quite a few are in the red and they don’t seem to have the potential to turn positive anytime soon. Some of the anticipated IPOs – the good, the bad and the ugly -:
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