The Facebook IPO: Can $FB Valuation Be Justified?

A guest article from Sanjay Mehta on the The Facebook IPO and Can $FB valuation be justified?


The world witnessed history being created with one of the biggest public offerings of equity, in terms of the Facebook IPO. The event was awaited with bated breath for last several months, and became a frenzy as the date neared. The most intrigue was around the valuation, and ultimately when the band was decided and when the final number was fixed, there were enough and more opinions about the number.

So while there was demand for paper of this social networking hero of a stock, there were far too many people who thought that the stock was greatly overvalued. Words as strong as ‘this being the biggest scam’ floated around.

So what to make of all this? Was the value justifiable? In the next few years, will the stock become a prized possession, or will a lot of people be stuck with large losses on the account?

At the outset, I would like to clarify that I don’t particularly understand stock market valuations. All those dizzying data points that people throw around, in terms of ratios and multiples and what not, I don’t really get those well. To an extent, as a participant in the Internet economy, if one may call it so, I have a view on the industry, and beyond that, I can just take recourse to some common sense views. My views on Facebook and its valuation are based on these perspectives.

Let me take on first, a few commonly heard objections to the stock value.

The first one, which to my mind is the most ridiculous one, is a comparison to brick and mortar businesses. Something in the lines of ‘how can an Internet stock be as valued or more valued than so-and-so large company, with such a big manufacturing set up, or whatever’. The same kind of comparisons floated when Facebook acquired Instagram for $ 1 bn. As to how Instagram, for example, be more valuable than Voltas or Thermax or whatever.

I find this whole line of thinking to be flawed. Can you really compare apples and oranges? While taking nothing away from large and successful brick and mortar businesses, how can there be a sweeping statement that an Internet business cannot be more valuable than those? Guys, we are in 2012. The world has shrunk. An 11-member team putting fancy filters on your mobile photos can generate 30 million worldwide users, without setting up global offices and distribution networks on ground! It makes efficient use of capital, and generates traction for its services. And is valued for the same. Why should anyone jump to the conclusion that this value is less or more than any traditional business? Same is the case with the gigantic Facebook with its 900-odd million user base!

For all I care, some of those on-ground businesses might have locked up their money in bad physical assets or in inefficient capital usage, and destroying shareholder value right there!

The other objection that I read comes from comparisons with previous companies that listed, and their multiples and such.

Here’s my view: History is not always the best place to predict the future!

There was never a previous business model that connected such a large percentage of all the people on earth, and got them to share more and more of their lives, via it. This is a first of its kind, in this new world that we are living. What kind of an impact this connectivity gives, now and in future, is for us to see. So how can this company’s valuation be compared to some other one, which had a more known and predictable business model? Well, one can attempt this comparison, but it may not be the best way to predict the value of Facebook.

That there is a very different rulebook here can be gauged from the valuations of the likes of Instagram. At nearly zero revenues, ANY valuation will not be justified, if the “multiples” and such other factors are to be taken into account. Yet, it got a cool billion dollars of valuation.

So keeping aside some of these rather inadequate objections on the value of the Facebook stock, what is it that can make the stock attractive in the years to come? Just as other Internet businesses such as Amazon had overcome the many hiccups in its way, what will it take for Facebook to overcome the challenges in its way, and continue to reign supreme, producing huge value for its stockholders??

The key to this will be an absolute and relentless focus on delivering value around a key proposition that the brand stands for.

Let’s look at Amazon, for example. Through the many ups and downs that Amazon went through, there was one obsession that it had, and which it worked on, relentlessly.

Amazon focused on the online shopper and strived to understand this shopper better, then some more, and then even more. Till the point that Amazon was able to provide better and better value to that online shopper. With that relentless obsession to understand the online shopper and deliver better value to him, Amazon came out on top and is the winner in the space that it is!

Likewise, if all that Facebook is focused on in the connected individual in the world, it must focus on understanding that connected individual better. Constantly figuring the needs and drives of this connected individual and giving him more and more, and being more and more relevant to that individual, can work for Facebook. A relentless obsession to be more significant and useful to the globally connected individual will ensure continuing leadership, and with the size that it enjoys, this leadership will certainly generate desired dollars that the analysts are worried about!

Another example to look at is Google. Google clearly understands that search is its base. Not just from revenues but also from unique recall, there is nothing quite like Google, for search. And for a long time Google also focused primarily on understanding the online searcher and improving the experience for him. Till the time that it lost the game to the SEO gang. Then, with SEO manipulated results, what we started seeing were not good search results, but terrible, SEO manipulated ones. At that time, instead of figuring out the story, and putting a halt to such SEO junk, Google was either busy counting the search advertiser’s cash or was busy trying to go away from the searcher, and move towards the connected individual (otherwise, Facebook territory).  The moment that Google stepped off the search pedal and has started dabbling in other things, they’ve been at risk. In terms of staying relevant to its users.

The bottom-line that I make here is that online businesses are a different breed than traditional ones. Serious global market domination is possible in today’s connected world and if there is one company, which is bang in the middle of it all, and an undisputed leader today, it is Facebook. If it stays focused on its core value proposition for its users, it can keep growing, both in terms of numbers and revenues. And rest assured, there will be revenue opportunities in ways which we cannot even imagine today. So let’s not apply the simplistic comparisons from factors that we know today.

On the whole, I am not sure if a $38 price is the right one or not. Also it is hardly about “today”. I am not about to put a “day-trader” angle to this discussion. So if the stock falls or rises to an extent in the immediate future that is not what this discussion is about.

The point being made is that, in this new connected and small world that we live in today, there is this giant called Facebook, with an unmatched leadership position, and with a phenomenal opportunity to be a global dominator over the next decade and more. Would this position give the stock a justification of a huge premium? I’d say, “why not?”

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