Facebook: Lessons from the dotcom boom (and bust)

AccountingWEB founder Ben Heald is getting a sense of deja vu about the recent Facebook flotation. 

Social media and Facebook are here to stay. They’ve become a crucial part of the web ecosystem.  But it’s already becoming clear that following its public offering, Facebook benefited considerably from hype pricing. Even after a significant drop in price from $38 on 18 May to $27 at the time of writing, Facebook’s market capitalisation is $58bn.

But is its impact on our lives so unquantifiable that it merits such astronomical sums before investors can see what sort of business it is, and the revenues and profits it will generate?

My own experiences of Internet valuations stretch back to early early 2000, when Freeserve offered £60m to buy Sift, but then lost 99% of its value.  Until you’ve lived through events like this, it’s impossible to grasp the possibility that a company’s share price can drop so dramatically. There is nothing absolute about share prices: just because they’ve dropped 30%, it doesn’t mean they can’t drop 30% again and again.

Before you ask, we would have been locked in to Freeserve shares for three years.

We’ve seen hype valuations in the past, including canals, railways and a number of Internet businesses in 1999/2000.  Those with valuable products go on to become enduring businesses, but plenty don’t (Pets.com, Freeserve, etc).

Facebook may be the next internet behemoth, but I would advise potential investors to considered whether:

• Facebook is going to become the only social network in town
• Whether all teenagers will stick with Facebook for life
• It will succeed in its mission for all of us to share everything on Facebook
• It will out-compete other internet gorillas such as Apple, Google, LinkedIn, Microsoft and Twitter.

Internet history suggests that one site doesn’t end up dominating and Facebookers don’t (and won’t) interact with the adverts very much.

As we learned during the dotcom era, internet companies like Facebook should be valued on the basis of the profit it generates ($1.0bn in 2011). My guess is that it will become a £10bn-£50bn revenue business.

It’s not clear why Facebook should be valued on a multiple of 58 times its annual profits, compared to a multiple of 21 times for Apple. The equivalent revenue multiples are 16x for Facebook and 5x for Apple. Everyone involved in the flotation got greedy, so the float price was too high.

I think there are plenty of companies available much earlier in the hype cycle.