Jerry Pournelle: View from Chaos Manor, Facebook at $10 per share?



The tumult and the shouting dies, the Goldman Sachs and the sovereign funds depart.

That is to say that the Facebook IPO is over. And on today’s trading, those who invested money on the notion that Facebook is worth 40 or more times earnings per share have lost money.

I don’t know why anyone would be surprised.

Think on it: If you bought Facebook at the initial price of $38 — and in doing so money in the bank for the founders, employees and early private investors in Facebook who certainly would like to have your money — you have bought paper that Facebook will need 40 years to be able to buy back.

The alternative is that Facebook will cleverly invest its earnings in a way that causes other people to buy that paper for what you paid for it. Or that enough people out there will decide that this is such a good deal they have to get in on it — and they will bid more for your paper than you paid.

The market valued Facebook, as I said, at about 40 times earnings. By contrast, Apple is trading at about 10 times earnings. And Google trades at about 12 time earnings.

Of course Facebook can grow. It only has a billion members. It can get more. Surely there is great potential for growth here. And it can advertise to them, and companies will pay to run those ads. Facebook shares will rise, double in value, even.

That’s how you create a bubble. But it didn’t happen that way.

Today Facebook is underwater, now down to below the initial offering price. It is likely to fall more. Those whose orders got lost by the buggy NASDAQ software and thus didn’t get in on the IPO turn out to be the lucky ones. Even more lucky — or astute — would be the initial stockholders who sold out at the IPO price.

At least it looks that way.

I predict that the end of the hype will be the end of the Facebook bubble — and the price will continue to fall until Facebook is down in the region of 10 times earnings. Even at that price, though, it will take Facebook 10 years to earn enough to buy your share — just as it takes Apple or Google that long to make enough to earn enough to buy their own shares.

Given current earnings, Facebook would be worth about $38 divided by four, which is to say less than $10 a share.

Will it fall that far? Who knows, really?

But without a lot more expected revenue — either real revenue, expected revenue from exciting new ideas into revenue or converting its huge membership to a revenue source and advertising it — that’s unlikely.

I recall Microsoft shot up from its first days after going public. That was because its co-founder and then CEO Bill Gates had the vision of a computer on every desk, in every home, and in every classroom, with Microsoft software running on every one of those computers. Microsoft pretty well achieved that. Apple was practically dead before the Return of King Jobs, whose visions of smartphones and elegant tablets brought it back from a minor player to a giant worth 10 or 12 times earnings. After Jobs’ untimely death, the stock stays there partly because of momentum and partly because Jobs infused Apple with his vision of how to take the inevitable new technology and turn it into something everyone would want.

Google is there because – well, that depends on who’s talking. But for Apple or Microsoft or Google to get up above 20 times earnings would take a lot of vision and a ton of razzle-dazzle to sell it.

There was a time when people bought stock based on expected dividends. Yet American tax laws have made it far more worthwhile for corporations to use their revenues to increase the value of their stock rather than concentrate on steady profits and dividends over the long term.

That encourages speculation and bubbles. You end up paying less tax on money “earned” by razzle-dazzle rather than on income from making the good stuff and selling it at a profit.

The result: Companies devour one another, buying up their competition and doing just whatever they can to increase capital gains.

One remedy might be to tax interest, dividends, and capital gains at the same rates. After all, they are returns on investments made with money you’ve already paid taxes on. But that doesn’t seem to be in the realm of political possibilities. Thus we have all this focus on growth and razzle-dazzle and not so much on just building a solid company that makes stuff people want and will want to buy.

That’s not the way capitalism is supposed to work, but it’s what we have.

That’s the View from Chaos Manor here at aNewDomain.net

Email me at Chaos Manor with your questions and comments at Jerry@aNewDomain.net.

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  • Justin Krezelak

    The valuation was ridiculous. I mean utterly ridiculous.

    Having said that…let the price keep dropping as far as I’m concerned. There’s an entire different way to approach this. Let the price drop as low as possible….buy up as much as you can realizing eventually it will stabilize at some point in the future and then cash out on a short term peak. Screw get rich quick pipe dreams….just make a profit.

    It’s a fairly simple way to make a quick buck. Too bad I don’t play this stock game so what do I know? Except for being completely right of course.

    Doesn’t anybody play the long game anymore??  I mean what idiot thought they were going to instantly become rich off this nonsense?  Oh…right…lots of idiots.

  • Gina Smith

    Jerry, I believe you are dead on. Forty times valuation is and was ridiculous. I wonder how much lower will it go. Dvorak called it on a show we posted here last week — he said the smart money will buy quickly and sell quickly.

    Nasdaq’s flaws probably saved people more than it harmed Facebook. There’s still time, though, but STILL. Madness. As you say, that’s how a bubble happens.

  • Johnfblackmon

    Never invest in hot air…..

  • http://twitter.com/jlesniak Jeremy Lesniak

    Yesterday I wrote an article on this subject for a local paper… it’s quite validating to see that someone I respect and admire came to the same conclusions I did.

  • Bobd2754

    Excellent points,  Mr Pournelle. I couldn’t agree more, this is nothing like capitalism, at least not the kind I was taught about in school. Tax laws need to be changed, but that won’t happen if we keep re-electing the people that benefit from the tax laws, and election reform won’t happen for the same reason. I guess we’re SOL. SO when is the next real estate bubble gonna be so I can sell my freakin house?

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