This guy’s company may be now worth $50 billion. (Photo: Robert Galbraith/REUTERS)
There are a growing number of signs that a bubble is building in tech.
The latest and potentially most disturbing: Investors now believe Facebook is worth $50 billion. Facebook is indeed an innovative and very successful company. It has 550 million users, and accounts for about 1 of 4 American page views. And, as you have probably heard, we at TIME named Mark Zuckerberg, Facebook’s CEO, the Person of the Year. But the company isn’t making that much money yet. Its revenue, while impressive and probably growing fast, is nowhere near $50 billion. And because it has undertaken an unorthodox means of making money, it’s not clear when the big bucks for Facebook will start rolling in. It has also struggled with privacy issues. So are the high values for tech stocks, particularly Facebook, setting investors up for a dangerous fall? Perhaps. Here’s why:
The $50 billion valuation for Facebook comes by way of a group of investors led by Goldman Sachs. They are putting in $1.5 billion into the social networking giant. The NYT’s Dealbook says the investment values Facebook at $50 billion, though it doesn’t give much back up for that fact. By my math, that means Goldman & Co. are buying 3% of Facebook. (More on Time.com: See TIME’s cover story on Mark Zuckerberg as Person of the Year)
Facebook shares, which aren’t publicly traded, do exchange hands on small private markets. And they have been trading up recently. Still, the most recent transaction for those shares put the value of Facebook at just over $42 billion. But the company may not be even worth that much.
To put Facebook’s supposed valuation in context, consider this: $50 billion is roughly equal to the size of the economy of the Dominican Republic. The Gap has a market cap of $13 billion. McDonald’s market cap is only $83 billion. So based on the currently deal, Facebook is worth nearly 4 times the Gap, and nearly two-thirds as much as McDonald’s. Of course, Facebook and the like seems where our economy is going, at least a portion of it. And the market has long given much higher valuations for tech companies than for retailers and others. So a much better comparison for Facebook would be to other tech companies. But even on those comparisons, Facebook looks overvalued.
NYT’s Dealbook says Facebook has $2 billion in revenue. That might be high. Our own reporting at TIME, for Zuck’s Person of the Year story, put Facebook’s revenue in 2010 anywhere between $1.1 billion to $2 billion. Still, even if you go with the high-end of our scale, as Dealbook seems to have done, the recent Goldman & Co. investment gives Facebook a price-to-sales ratio of 25. Is that high? It appears so. Apple has a price/sales ratio of 4.5. Even Google’s price/sales ratio is just under 7. (More on Time.com: Photos: Life inside Facebook’s headquarters)
That’s not to say that Facebook doesn’t deserve a higher valuation than Apple or Google. Companies that have high margins, meaning that after expenses they are able to turn a large portion of their sales into profits, tend to get higher valuations from the market. But Google has a profit margin of a 29%, which is already quite high. (The Gap’s profit margin is 8%.) Facebook’s profit margin is probably quite large as well. Afterall, like Google they don’t have a lot of stores. And Facebook has relatively few employees for all of its success. But is Facebook three times a profitable as Google? Probably not. So far the company has not embraced banner ads, which is the traditional way people make money on the Internet. So while most people believe Facebook makes money, right now, until its new model develops, it probably doesn’t make a lot.
What’s more, there is good reason to believe that Goldman is purposely overpaying for its investment in Facebook. The tech company is reportedly considering a 2012 initial public offering. The IPO will generate hundreds of millions of dollars in fees for the investment bank that leads it. Goldman, which is putting $450 million of the its own money into Facebook, wants to be that investment bank. So Goldman may be willing to pay much more than a typical investor because it is factoring what it may make it fees later on. And by bringing in other investors at the same, inflated, price, Goldman is only proving it will be able to do it again with the IPO. The co-investors, too, could be paying off Goldman for preferential treatment in other deals by agreeing to overpay along with Goldman, for now, for Facebook. (More on Time.com: Now that Facebook is valued at $50 billion, will it go public?)
Lastly, Facebook has a lot of company in the growing tech/social media bubble. Google recently offered to pay $6 billion for social-networking-coupon company Groupon, which is less than two years old and has well over a dozen rivals doing essentially the same thing. Groupon’s founders amazingly turned Google down. They think their company is worth much more. Another sign of the bubble in techland: Shares of OpenTable, a web site that lets you reserve tables at popular restaurants, have risen nearly 200% in the past year. But outside of large cities will OpenTable ever have a lot of users? Here’s how one analyst put it on Seeking Alpha:
To justify its current share price, OpenTable is expected to capture the entire market share of its primary business, generate equivalent revenues by some other means, and operate with no expenses. These are obviously unreasonable expectations.
Tom Hoenig, the President of the Kansas City Fed, has been a vocal critic of Federal Reserve Chairman Ben Bernanke’s recent policy of keeping interest rates low for an extended period of time. He believes this will eventually lead to new and harmful speculative investment bubbles. We might already be there.
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