At its height in 1999-2000, it had over 30 million subscribers
-- almost one-quarter of all Internet users in the U.S. at the time
-- and was growing 25-30% annually. By 2000, its nearly $7 billion
in sales had been growing 35-50% annually in the culminating
At its peak market capitalization in 1999, it was worth $250
billion. Time Warner liked it so much that, in 2000, they decided
to merge with it. At that peak, I get it was valued at 35x
revenues, 138x EBITDA, 216x cash flow.*
I'm talking about one of the hottest items of the then-nascent
Internet age in the late 1990s. I'm talking about America Online (
). For about $22 a month, you too could sign up to wait about 20
minutes (if you were lucky) for your dial-up modem to connect you
to their online community. It was an unstoppable business model.
Until everyone realized one day, you don't need to pay anything for
that (subscription fees were two-thirds of its revenue model then,
the rest mostly ads) and it could be readily replicated away for
Fast forward to today … As of year-end 2011, AOL is now down to
3.3 million subscribers (and only 36% of its revenues are now from
subscription fees), out of the now 2.3 billion Internet users
worldwide. That's down from 4 million in 2010, 5 million in 2009, 7
million in 2008 … and oh yeah, the over 30 million in 2000. With a
current market cap 1/100th that of its 1999 size (since spun off
from Time Warner in 2009), it is now valued at 1x revenues, 6x
EBITDA, 7x cash flow.
Today the latest hot thing is Facebook (
It IPO'd at $38 per share last Thursday, with its first day's
public trading opening around $42, declining back to $38 by the
close. Facebook boasts over 900 million subscribers, growing
~25-30% annually (down from doubling three years ago). It has now
penetrated nearly 40% of the world's 2.3 billion Internet users
(they had only about 10% penetration just three years ago). Its ~$4
billion in sales is growing around 45% annually (recently goosed by
an uptick in advertising revenue).
At the $38 IPO price, its market capitalization is about $104
billion. I get that to be a total enterprise value of 28x revenues,
45x cash EBITDA, 62x cash flow (all 2011).*
For perspective (albeit a bit off the top of my head) more
"normal" looking valuations for "older-world" businesses range
around ~1-2x revenues, ~6-9x EBITDA, ~10-15x cash flow. But
valuations price growth. Those less-lofty, broader market multiples
would typically be pricing ~4-8% growth.
So the big, fat stupid question is (always is), how high is too
high? The corollary, when are we in a bubble? The only good answer
is, until there are no more fools left willing to buy it there.
Every other "explanation" is just a bunch of people trying to make
money selling books.
But to slap some numbers on it, Facebook subscribers are growing
at 25-30% right now. Worldwide Internet users are growing at
10-15%. Facebook subscribers are 40% of all Internet users. At
these current growth rates, there will be more Facebook users than
Internet users five years from now. Which is impossible. Even for
The point is, Facebook subscriber growth has to start
decelerating dramatically at this point. It's just simple math. If
we run subscriber growth out at a rate declining to about 15% by
2016 (still robust), by 2019 Facebook will have 3 billion users, or
58% of all Internet users. Right now, Facebook makes $4.70 in
revenue per subscriber (up from $2.16 in 2009). If we hold that
constant, then Facebook will be generating $14.5 billion in
revenues in 2019. That values Facebook at 7x 2019 revenues. At that
point it will be a more mature business, but still growing the top
line in the mid-teens.
Apple is an iconic and transformative company. It is a mature
business, but has managed to reinvent itself and remain "cool" for
a few decades now. With the explosive success of iPhones and iPads,
etc., Apple's sales grew 66% in 2011. 52% in 2010. Apple (
) presently trades at 4x 2011 sales.
Again Facebook, with current growth of 25-50%, debuted at 28x
2011 sales. According to the market then, Facebook is "just" seven
times cooler than Apple. If Facebook does everything perfectly for
the next seven years, it will then be at a valuation "only" nearly
double Apple's current. Beauty, of course, is in the eye of the
beholder, but can we start to see that perhaps Facebook's present
valuation is maybe a little too beautiful?
And then to compare Facebook to America Online of 1999 is, of
course, absurd. AOL was a subscription fee-based model; Facebook is
mostly an ad-based model. They aren't in any way alike other than
they are both Internet-based subscriber services. That both came to
be regarded society-wise as a ubiquitous online utility. And they
both offer their subscribers access to their "closed garden" online
communities through chat and news. And they both offer a secondary
suite of products [Zynga's (
) games and apps for Facebook; Compuware for AOL]. And they are
both the absolute craze of their respective times. And they both
boasted explosive growth in just several years' time. And they were
both growing off a relatively new business model only a handful of
years old. And their shares both traded, thusly, at mind-bogglingly
high market valuations.
Aside from that, absolutely no similarity whatsoever.
I am of course being a bit facetious. But only a bit. 28x sales
is ridiculous. It is. It just is. Turn off CNBC. Pay attention.
There was a time, maybe five years ago, where 5x or 10x sales for
fast-growing tech or Internet-based stocks was considered
Now we're chatting once more about 20-30x sales valuations. The
last time we got there … was the dot-com bubble of the late 1990s.
A bubble that peaked in mid-2000, with the tech-laden Nasdaq
Composite Index's peak. From there the Nasdaq proceeded to crash
ultimately almost 80% -- a decline as severe as the 1929-33 stock
market crash -- and still is only half its peak after over a decade
The difference now, versus the late 1990s, is the bubbles only
exist in a handful of hopefuls -- the poster child right now being
Facebook. The overall market - unlike the late 1990s - is not
expensive. It has just clawed its way back to rather normal looking
valuations that it had already achieved, pre-financial crisis by
2007. To embellish, the S&P 500 Index P/E, in 2007 and now, is
a very average looking 13-16x. By 1999 that was over 30x -- its
highest ever. In other words, the entire stock market of the late
1990s, unlike now, was expensive. This is a possibly important
caveat that may allow ridiculous individual overvaluations to
persist longer than they otherwise should.
A valuation of 20-30x sales though, prices in everything good
that could possibly ever happen to a company -- whether it happens
or not. For Facebook, it means that mobile app users, growing at
50% annually (read: faster than overall Facebook user growth),
won't cannibalize ad revenue for it anymore, as Facebook admits it
is a risk in their public filings. (Ads can't presently be shown on
smart phone Facebook apps. Thus that app use generates no income
for Facebook. Facebook does not control that. Mobile users are more
than half the size of total Facebook users.)
It also prices in no weariness; no boredom with the "new toy".
No risk that the kids won't think it cool one day anymore (
MySpace). No annoyance for the huge uptick in ad presence on your
timeline. On your banner. On your photos. On your news feed. Its
valuation relies weightily -- if not solely at this juncture -- on
the fact that there is no other place for nearly one billion users
to otherwise go. For now.
After all, as subscriber growth now decelerates, increasing ad
volume (and/or ad fees) must compensate. This comes at the risk of
annoying either subscribers, advertisers, or both. And who knows if
others will follow GM's (
) recent decision to leave advertising on Facebook because not
enough people clicked on their ads.
But it is a risk. And 20-30x sales valuations do not account for
that risk. Such a valuation also prices in the assumption of
successfully breaking into brand new markets, like the Chinese for
example. Or Klingon or Vulcan or Romulan for that matter.
None of the aforementioned is impossible, or even improbable
(well, maybe the interstellar bits). But the world is a fragile
place still in the wake of the financial crisis. It is not a place
where the benefit of the doubt is typically given to publicly
traded companies. 20-30x sales gives all that and more to Mr.
Zuckerberg and his management team.
They have done a spectacular job in the past several years
fulfilling the American dream -- running a small, upstart private
company, with focus on finding new rounds of private capital
investment to fund, while it grows an unprofitable model into a
profitable one. That's what they have several years of proven
But they are a public company now. As I write, they have exactly
one business day's experience in delivering, to the penny-plus-one,
quarterly results to a herd of frenetic public investors.
20-30x sales places consummate confidence in them that they'll
continue to deliver for many, many more years to come, with never a
misstep. And that they'll be naturals at their brand-new and yet to
be proven fiduciary duties toward maximizing value for all public
shareholders -- irrespective of the fact that the insiders still
hold 95.9% of the vote (Zuckerberg 55.8% himself).
But Facebook is different from most companies. It is a
revolutionary and transformative icon of society. And to that,
Facebook should command a higher than otherwise market
So was America Online, by 1999. And it did as well. Right up
until it didn't.
Like I said (even facetiously), Facebook is no America Online.
But at 28x sales, before jumping in, is it not prudent to give
them, say three reported quarters, to show us they know how to
behave like a public company? Let the hype blow over?
Especially with Europe's now two-year slow motion train wreck
debt crisis, China's real estate and banking sectors teetering, our
own unresolved fiscal drama and while globally wallowing in a soft
economic depressive state?
I think you know the answer. Unfortunately though, even "smart"
people can be trampled by the crowd.
* Total enterprise value ("TEV"), as a multiple of these
measures. TEV is the equity market value, diluted and adjusted for
in-the-money granted stock options assumed exercised, plus debt,
less cash on the balance sheet. EBITDA is earnings before interest,
tax, depreciation and amortization expenses. Cash EBITDA is EBITDA,
adding back non-cash stock compensation expense. Cash flow is cash
EBITDA, less capital expenditure.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
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