Facebook is NOT overvalued..here’s why:

“But the multiple is higher than Google’s or Apple’s!”

Two short paragraphs of finance nerd talk..then some interesting stuff:

Nerd Paragraph 1: How to value a company

Valuation is a science not an art.  Valuation is literally a math equation.  To value a company, you discount future cash flow expectations (i.e. dividends).  Multiples are just a short hand way of doing that math.  But the math of a multiple has to yield the same value as the discounted cash flow (or “DCF”).

Nerd Paragraph 2: Variations in value

Wide variations in valuation expectations are caused by differing assumptions on a company’s future cash flow.  Not the discount rate (or multiple) .  With early stage companies, financial models are worthless.  The delta on future cash flow assumptions is too great for early companies.  However, you can absolutely apply DCF modeling to value companies that have established business models.

Facebook is not the next Google, and that’s bad for Google

The Bear case for Facebook is that its ads do not perform as well as Google’s search and thus Facebook will never be as big.  Look no further than General Motors pulling its $10 mil biz and Facebook’s own decreased revenue projections (which the bankers creepily seemed to hide from most investors during the IPO road show).  In my opinion, anyone who makes this argument for a reason to sell Facebook’s stock doesn’t actually understand Facebook’s business or is a conflicted day trader.

Facebook ads will never perform as well as search.  Nothing matches specific search intent.  Certainly not demographic or interest targeting.  Being interested in cars or reading a book on cars does not match the lead generation quality of an actual search for local car dealers. No one would dispute that.

It’s All About Payment Processing Baby!

I will grant the Bears one thing, if you only look at Facebook’s advertising business, it is very difficult to justify its multiple.  Clearly the growth rate of the ad business has decreased.  Mobile is a threat.  The low hanging fruit of buying “fans” has been picked.  From a high level perspective, Facebook’s current ad products look a lot like cash cows – nice, modest growth, and high margins.

Explosive Cash Flow growth will come from one of two places.  1. Innovation on the ad business (i.e. new products to existing customers); or 2. Payment Processing.  I am not sure that even amazing innovation on their ad business can justify the growth required to match the valuation expectations.  So to me, it all comes down to payment processing.  Huh?  Facebook does payment processing?

Facebook’s Most Valuable Asset

In my opinion, Facebook Connect will become a more valuable asset than Facebook.com.  Facebook Connect is that Facebook button you see all over the web that allows you to log-in to a site using Facebook, or Send content to your friends or add a comment to an article.  It provides publishers amazing data, and so it has wide-spread adoption.  This product is amazingly powerful for Facebook because a user is always connected to it while surfing the web.

There are a lot of ways to monetize this uber-connection, but I think Facebook picked the best way when it launched Facebook Credits.  Very few people talk about Facebook Credits because the product can only be used on Facebook.com right now, and it is mostly contained to gaming.  But since gaming is a huge on Facebook.com, the product has a large established base of users that use Credits and help Facebook refine the product.  Oh, and it is producing a half of a billion in revenue.

Einhorn, Finkle…Finkle, Einhorn

To all of those non-Ace Ventura fans out there, Facebook Connect will become the key driver of Facebook Credits outside of facebook.com.  They will become one and the same.  And it will happen very soon.  Facebook has all of the pieces in place to make Credits a humongous payments business.  And when I say humongous, I mean very, very friggin big.  I mean a huge threat to PayPal, Visa, MasterCard. AMEX, etc.  And the margins are really good in that business model.

I am a long-term investor

Let me clarify one thing.  I have zero opinion what Facebook’s stock price will be next week, next month, next year.  That is not how I think.  I think long-term.  I am a buy and hold investor on public equities.  And I am adding Facebook’s stock to my portfolio.

Published by v1again

I try very hard to be a great father, husband and entrepreneur. Founded and sold 3 companies. Winware.ai is my 4th startup.

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