When something is unlike anything we have seen before we look for analogies or comparables to try to put it in context. Investors didn’t know what to think the first time they saw Microsoft (MSFT), later Google (GOOG), and now Facebook. Today Techmeme has stories from The New York Times “The Facebook – Microsoft Parallels” and Wall Street Journal “Facebook Versus Google Circa 2004” which try to compare Facebook and put things in context. CNN also jumps in with “Facebook Hype Will Fade” and compares Facebook to Myspace, Friendster, and AOL. Comparing is the logical thing to do when we don’t understand something. But, how do you compare “one of a kind” incomparables?
Last week I wrote “The Best Properties Always Look Too Expensive” which attempted to explain Facebook’s valuation psychology and why market leaders/innovators always command the highest prices. I used a real estate analogy that my father-in-law taught me many years ago. He bought many prime commercial real estate properties to build his business and told me he overpaid every single time. It was only a few years later he looked like a genius and the property looked like a bargain. He didn’t overpay at all…he just saw the future value before most other people did.
Real estate is easier to value than technology because there are so many alternatives and comparables, or “comps” as they call them in the real estate business. Yes, there are “one of a kind” properties in real estate. But, there are always workable alternatives, and price comps that have been established by the marketplace. So, in real estate you might overpay by 10%, maybe even 20%, but time and a rising market covers up all mistakes.
Technology companies often don’t have comps to assist in valuation. Investors or corporate acquirers are left to develop their own scenarios and synergies…and often miscalculate. And, they don’t just miss by 10% or 20%, they miss by 100% or 1000%. When Time Warner acquired AOL, or vice versa, it was a $350 Billion dollar miscalculation. There have been many others. See my earlier post “The 10 Worst Billion Dollar Acquisitions“.
So, which is it? Are the best properties always worth their high prices? Or, does hype, and lack of comps, often push valuations beyond all logic and reason? I think you know the answer…there are examples of both.
Should investors view Facebook like Google or Microsoft? No, not in my opinion. There are curious parallels, but not comparable. They are three very different companies, in very different businesses, led by different people, at different points in time.
Is Facebook overvalued at $50B? Many people thought Zuck should have sold when Yahoo reportedly offered $1B. Then they thought Microsoft was nuts when they invested $240M in Facebook at a $15B valuation. Are the smartest deal makers on Wall Street crazy when they invest at a $50B valuation? The pundits have been wrong every time. However, pundits are like fortune tellers…they make lots of predictions in hopes of being right once…and being forever known as “The one who called it”.
Is Facebook at its peak, as the CNN article says? No, I don’t think so. Ahead of itself perhaps, but not at its peak by a long shot. Facebook doubled revenues last year, and is just starting to try different revenue models like Facebook credits and revenue shares from casual games.
BTW, have you ever clicked on a Facebook ad? I have been using Facebook for years and have never clicked on an ad. But, a whole lot of people must be clicking on ads for Facebook to generate over $1 Billion in revenue.
We naturally view the world through our own eyes and experiences. But, when evaluating investments this can create lots of blind spots. Surprisingly, stock market valuations and acquisition prices involve a lot more gut feel and emotion than you might expect. People arrive at their own conclusions and then look for comparables or synergies to justify their decisions. Investors should be careful doing this when looking at “one of a kind” assets.
Disclaimer: The views and opinions expressed here are my own, and do not reflect those of my employer. I am not a professional investor and you should not rely on anything written here. Consult your investment advisor for investment advice.
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