Facebook: The IP-NO!

Everyone has a take on the Facebook (Nasdaq: FB) initial public offering. I'll confess that it just depresses me. Like John Lennon said, I'm just a jealous guy. Too many people are getting rich. And there's too much hype. And the public investor can't really be a part of it, because the valuation will be insane.

IPOs were once thought of as the way for the average investor to get in on the ground floor of a company that could grow for many years and become one of the largest in the world. But Facebook, which filed to go public yesterday, won't be one of those. It will likely debut as already one of the largest companies in the world. Experts are putting its value at more than $75 billion -- potentially as high as $100 billion.

That valuation is insane for an IPO. It will be one of the largest technology IPOs ever. Facebook is aiming to raise about $5 billion in capital and achieve a market cap of more than $75 billion. Google (Nasdaq: GOOG) raised about $2 billion and had a market cap of $23 billion after it went public in 2004, nearly a decade ago.

The S-1 filing by Facebook shows it made about $1 billion of profit on $3.8 billion of revenue in 2011. Not bad numbers. And the profit number ($1 billion) is nice and round. Let's use a $100 billion valuation, just because it's a fun, round number, too. That means Facebook would be trading at 100 times trailing profits. In other words, it would have a trailing price/earnings ratio of 100. With sales of about $4 billion, the price/sales ratio would be 25.

The problem is that such high multiples -- and such a large valuation -- mean huge amounts of growth are already built into the price of the company. Now, this wouldn't be a problem with a company that had, say, a valuation of $10 billion. But $100 billion? Even if Facebook's valuation came out at $70 billion, it would be one of the largest companies in the world, though it would have a fraction of the revenue of the largest companies.

Let's say you just wanted to double your money off an IPO of nearly $100 billion. You'd want the market cap to grow to $200 billion. That would mean Facebook would become half as large as Apple -- or just a little bit larger than Google, which has a market cap of about $190 billion. Apple is expected to make about $40 billion in profits this year, and it trades at a P/E ratio of 10. For Facebook to have the same P/E valuation, it would have to increase profits 3,000% -- nearly 30-fold. How long do you think that would take?

What about Google? It has about $10 billion in annual profits. To match that, Facebook's profits would have to grow 1,000%.

To get a sense of the scale of the Facebook IPO, take a look at the chart below. It looks at a bunch of companies in the $50 billion-$200 billion market cap range.

Table 1: Potential Facebook Peers

Company	Symbol	Market Cap (2/2/2012)	P/E	Price/Sales
Google	GOOG	190B	19	5
Merk	MRK	116B	28	2.5
Cisco	CSCO	107B	17	2.5
Verizon	VZ	107B	44	1
Qualcomm	QCOM	103B	24	7
McDonald's	MCD	101B	18	4
Disney	DIS	70B	15	1.7
Hewlett-Packard	HPQ	57B	9	0.5
Goldman Sachs	GS	59B	25	2
Facebook (projected)	FB	80B	80	20

It's interesting that other media and Internet conglomerates are included. Like Google, Facebook is really a combination of a technology company and a media company, since it derives most of its revenue from advertising.

How did we get here? The IPO market isn't what it used to be. Most of the hot technology companies are staying private longer, so the most spectacular period of growth happens in the private markets. This means private investors that get in before a company goes public make the most money. Accel Partners made one of the first large-scale investments in Facebook at a valuation of $100 million. The return on its investment will likely exceed 7,000%!

As I mentioned, all of this makes me a bit depressed. It used to be that you could buy great technology companies in their formative stages on the public markets. That's becoming harder and harder to do.

Let's take a look at Microsoft, which went public March 13, 1986, at $21 per share. If you bought one share at the IPO price, it would now be be worth $7,200. That's a 34,000% rate of return. What if you had really splurged and bought 100 shares? That would have set you back $2,100, and the stock would now be worth $720,000. That's right. You could have made nearly a million dollars with a $2,100 investment. That's as good as a venture capital investment in Facebook!

My dad and I still joke about this, because I entered college in 1986. It would have been nice to take that tuition check and pump it into Microsoft stock instead.

Now that is going public, Facebook would have to become a $10 trillion company to return another 10,000%. Anything's possible, but that probably ain't happening, folks.