Photo: Bloomberg Television
From his blog post yesterday:
I would be very surprised, if the stock were overpriced; the bankers and the company have too much too lose. I would be equally surprised if the stock were dramatically under priced; a pop of 50% or even 25% would reflect very badly on the bankers’ pricing skills. In short, this is shaping up to be a Goldilocks IPO.
We followed up with Damodaran, who was quick to pat himself on the back.
“I’d like to claim that it was some brilliant insight on my part,” he said. “But this is the most telegraphed IPO of all time.”
But he warned that some of the trading activity could be a bad sign for social media companies. The fact that the 10% bump faded so quickly is bad news for Facebook and other social media companies could be a signal that momentum is fading for the industry, he said.
He added Facebook is a promising company, but it will have to perform “to perfection” to justify this valuation. Anything less will be seen as a negative surprise by investors.
Here’s a full transcript of our conversation with Damodaran:
BI: Any comment on the IPO today? We found your blog post very prescient.
Aswath Damodaran: I’d like to claim that it was some brilliant insight on my part, but this is the most telegraphed IPO of all time. The way I describe it is as the IPO that was pre-priced more than any other IPO in history. Pre priced because you had the private share market and you also had the transactions happening before the actual IPO. With the standard IPO you really don’t know what the value is, you’re trying to figure out what the demand and supply is. This one, they were calling it late last night. I’d have been extraordinarily surprised if they got it under by 50% or over by 20% simply because the supply and demand were set. So the initial opening was in fact very much in line with what you would expect from a scripted IPO which is what this was. But I think what happened afterwards which should have been troubling both to investment banks and to anybody investing in social media companies was how quickly that initial 10% bump started fading. In fact, the only reason I think it’s up today is because the investment bankers have been providing support. And you know what? With a $100 billion dollar company the investment banks don’t have enough capital to provide support for very long. So, once the support fades the question is whether it will drop to 38 by this evening, by Monday morning, by early next week, but it looks like its heading back to the offering price or maybe below, which is not good news. Not just for for Facebook investors, but as I think I mentioned in the blog, I think this is an early stage signal on how the momentum game is playing out with social media companies. So, if it doesn’t go well next week I think the momentum might be fading. Which, with the momentum game, always means that you have to worry not just future IPOs, but the LinkedIns, the Groupons, the companies that are already out there that are trading and what they can get in this marketplace.
BI: Do you think retail investors made any difference, or was it canceled out by the trends you described?
Aswath Damodaran: I don’t think so, I think we get swayed by the sheer numbers, but remember this is a $100 billion dollar offering, so everything is going to be scaled up about 50 to 80 times right? If you look at the retail investors in this IPO, I’m not sure the demand was much higher than the demand for LinkedIn, it just gets scared up because it’s so much larger of an IPO. So I think the stories about retail investors trying to break in, trying to get the IPO at any cost were overplayed, I always thought that they were. It was a big story, it was played out everywhere but I don’t think that the enthusiasm from retail investors was that much greater than other IPO, in terms of percentage demand of the total issue.
BI: What do you think of the valuation of earnings in comparison to that of other companies? is that something that’s going to push the stock price down in the long run?
Aswath Damodaran: I don’t think the earnings multiple means very much for a young company. I’ve never put much faith in whether its trading at 100 or 500 times earnings. This company is a baby in terms of operations, so earnings multiples are not very good ways of thinking about what a young growth company should trade for. But I think even if you took projected revenues or projected income, it’s trading at a rich valuation. It is trading on the assumption that those billion users can be converted to advertising revenues of $50 to $60 billion sooner rather than later. That’s a steep climb for any company, for a company with 4 billion in revenues to go to 60 billion. It is possible obviously, other companies have done in the past, but I think you’re pricing the company to essentially be a star. I mean, its like looking at Andrew Luck and saying “hey, where are your 3 Super Bowl rings?”. The guy hasn’t started playing yet, but the fact that you have a lot of talent and a lot potential doesn’t always translate into championships or into that type of performance. So, what I’m trying to say is that it is not inconceivable that Facebook is worth $100 billion. But I think that if you pay $100 billion, you’re asking the company to perform to perfection. That’s always a dangerous thing to do as an investor, because anything less than perfection is a negative surprise. Now, I think that’s my concern with a $100 billion value, people are extrapolating from existing circumstances way into the future as to how successful this company is going to be.
BI: So you think that the valuation has driven expectations to the point where Facebook is going to have a difficult time meeting them?
Aswath Damodaran: The expectations have been set so high that if Facebook delivers really good results it’s still going to be a negative surprise.
BI: This trend you saw where the private trading pre-IPO didn’t leave much room for a bump, is that something unique to Facebook because of the popularity and hype? Or is it something that’s going to continue into the future with IPOs, especially tech IPOs?
Aswath Damodaran: I think Facebook is unique, it was a quasi public company before it went public. It had all of the makings of a public company without actually trading shares on Nasdaq. So I think Facebook, because of its size and visibility, is unique. But I think this private share market is an interesting transitional thing, because you’ve already gone from being private, to VC, to public, now you have this intermediate stage where you’re going private, to VC, to private share market, to public, which might become part of the game. I’m not sure it’s going to be the only model but it is a model that actually allows some of the uncertainty to get played out in an intermediate market first before it gets to public markets. So I think that the private share market model is likely to stay and change some of the ways we think about IPOs in the future.
BI: How do you think its going to change it?
Aswath Damodaran: In a sense, what happens is that your company gets traded for about a year or two before it goes public. So you get transaction prices. These are not estimates of value that an investment banker is making, these are actual prices at which people are willing to buy and sell. Those prices are always more credible than values you estimate on paper. So if somebody actually bought a company for $1.5 billion, say Pinterest. Based on the transaction that they had a couple of days ago, the value is $1.5 billion. The reason people are willing to attach credibility to that value is that somebody actually paid based on that valuation. That’s what private share markets do, they allow you to see people buying and selling at prices and base your estimates on those observed prices.
BI: Any other comment?
It’s just one company. They way I describe it is that Apple has lost almost as much in Market Cap in the last 2 months as Facebook was valued out today. About $80 billion dollars have been wiped out. So, people are acting like Facebook is the second coming or the greatest company ever. But Facebook is a small company with an outlandish profile simply because of what it is. So I think there’s been too much macro storytelling about Facebook, that if the Facebook IPO went well the market would be cured. I don’t see that happening. This is just one company going public. If it has any effect it’s going to be immediate on the social media companies. I don’t see it changing the way we think about equity markets or equity risk premiums. Greece is still going to be there Monday, even if this deal had gone great. China’s slowing growth is still going to be there next week whether Facebook does well or badly. So I think we’re going to return to reality next week and recognise that the world did not change.
BI: This is a reflection on Facebook as a company rather than any weakness in equity markets?
Aswath Damodaran: Exactly, the equity markets, lets face it, the equity markets have been weak, but not because of Facebook. They’ve been weak because of macro factors, which are what actually drive equity markets. The Facebook IPO has implications for Facebook and for social media companies. So that small subset of the market is clearly going to be affected by this IPO. If it doesn’t go well I think its bad for Zynga, Groupon, LinkedIn and the other social media companies. Is it going to affect Microsoft, I don’t see why. It’s not bad for technology over all because technology overall is too broad. Its bad for a small subset of the market, but it has very little implication on the overall equity market because there much bigger worries on that front.