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Dave Sather's Money Matters: Investing in Facebook

By By Dave Sather
May 1, 2012 at 12:01 a.m.


For quite some time now, the calls have come in from people asking us if we're going to buy shares of Facebook at its initial public offering next month.

Whether a fan of the social networking site or not, this is an investment decision that should be fully evaluated from a business perspective.

For us, there are two issues that quickly come to mind.

The first is that in buying shares of Facebook you are allocating money hoping for a good rate of return. In the most basic of terms, you are buying a business and trying to determine what a fair price should be.

To begin this assessment, some simple Aggie math is helpful.

By all accounts, it appears that the initial public offering for Facebook will assess a value on the entire company of more than $100 billion. That is a very stout number and great if you are currently a Facebook insider looking for a monster payday.

However, if you are just a normal investor, what exactly are you getting? Remember, the long-term value of any business is the compilation of its earnings. As such, you don't want to overpay for earnings.

Based upon last year's figures, Facebook produced revenues of $3.7 billion. At a $100 billion value, Facebook would trade for 27 times revenues. Ouch!

In comparison, you can buy either Wal-Mart or Exxon for less than one times revenues. Obviously, neither Wal-Mart nor Exxon are expected to grow as fast as Facebook, but is the social networker really 27 times better than the world's largest energy company or largest retailer?

Of the $3.7 billion in revenues, Facebook reported net earnings of $1.1 billion. Again, a $100 billion value would put Facebook at 91 times earnings. We haven't seen numbers like that since the dot com craze - and we all remember how that ended.

Wal-Mart, Walgreens, Exxon and Microsoft all trade for 11 times earnings or less. As such, an investor has to ask themselves whether or not Facebook is really nine times as good as any of these highly predictable companies with tremendous staying power.

Setting valuations aside for a second, an investor should also consider the corporate structure of Facebook. Mark Zuckerberg, Facebook's founder, made news last week when he made a $1 billion acquisition of a privately-held company called Instagram.

What made this acquisition unusual is that Instagram has 13 employees and zero revenues. Let me reiterate that - zero revenues. As such, Zuckerberg paid $1 billion for a concept. At those prices, I have a few concepts I'd like to sell, too.

More oddly though was the fact that there was no bidding war for Instagram - just Zuckerberg and Facebook's corporate checkbook. There was no consultation with Facebook's board of directors, attorneys or other advisors. They didn't even know Zuckerberg bought the company until they heard about it on the news.

How can this be? Although Zuckerberg only owns 28 percent of the common stock, he owns 57 percent of the voting shares. As such, he controls 100 percent of the company. Given this, an investor in Facebook should expect no oversight from a board of directors, no compensation committee and no independent directors. All you get is Mark Zuckerberg.

None of this means Facebook will flop as an investment. It just means that any potential investor must be aware of the risks that are plainly evident.

Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.

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