Many people would argue that Apple is the strongest company today. The way it makes money, it almost resembles a bank. But if you applied the Apple valuation on Facebook’s revenue, Facebook would trade at about $12 billion, not $57 billion (as of market close June 6, 2012), down from more than $100 billion on its inaugural IPO date.
Also, if you look at other great companies, such as Oracle, Microsoft or SAP, and their valuations on revenue or on EBIT, those companies trade between $10 billion and $14 billion.
I’m basing this off of the barometer my team uses. Each quarter we introduce the MW IT Index. Our market-weighted-value index takes the market value of 120 companies grouped into four technology categories: IT services and business process outsourcing, IT supply chain services, software, and SaaS. The index assigned a value of 1,000 to each composite group on December 31, 2008, and it has tracked the category performance since then.
Bottom line is that SaaS companies are trading at a premium of 150 percent or more from the other segments according to our latest quarter.
Facebook initially traded at about a 300 percent premium above such SaaS companies as Salesforce.com.
Facebook was trading at 30 to 40 times revenue, compared to companies in the IT products and services space that are trading at four to 10 times EBITDA and SaaS companies that are trading at two to five times revenue. If Facebook’s financials were in the IT Services space, it would be valued between $4 billion to $6 billion, not $57 billion.
It just shows that the space you are in matters. SaaS, IT services, IT BPO and IT supply chain companies are valued quite differently than Facebook.
But people must remember that when they invest in Facebook, they are investing in a company with assumptions that are going to be very difficult to achieve over time. Assumptions that leave little margin for error are built into the price of the stock.
For example, in the ’90s, Cisco was going to be the first trillion-dollar company. But they didn’t make it. The reasons why do not matter — what does matter is that a very high bar was set.
So, the Facebook market expectation is set as high as they have ever been. In addition, Facebook’s CEO, Mark Zuckerberg, was quoted as saying in a recent article in New York Magazine, “We don’t build services to make money; we make money to build better services.” Most companies must do the opposite — make money then build better services. This is bearing out in the market reaction.
Today, Facebook has almost $4 billion in revenue and a billion in earnings. That is a real company. But, the market expectation might not be real yet, and there is little, or no, operating margin of error for the company to make its mark.
Plus, when we look into the future at possible competitors for Facebook, we don’t know who they are. They are probably in college or in a garage. That is why Warren Buffet does not invest in technology companies. Today’s technology darling can be obsolete tomorrow.
If you want to look at out-of-sight valuations, look at the SaaS space. If you want to leave the galaxy, look at Facebook.
We will see if they can meet expectations five years from today. That is possible.
The news that GM pulled its advertising will have little bearing on Facebook’s valuation. By the way, I assume you saw that Warren Buffet recently bought 10 million shares of GM.
Marty Wolf is the founder and president of martinwolf, a leading middle market IT M&A specialist. Since 1997, he has guided buyers and sellers in the IT services, business process outsourcing, supply chain and software industries through more than one hundred transactions, including divestitures of Fortune 500 divisions.