Facebook's value is not a trick question
Wall Street banks should ask new analysts to value the social network instead of giving them brain teasers.
When bidding for an investment-banking gig at Lehman Brothers, I was asked to value a proposal by General Electric (GE) to buy up a chain of laundromats and detergent companies. Since GE makes millions of washing machines, the interviewer wanted to know how I would go about advising the industrial conglomerate on a plan to add verticals. (I wound up far from Lehman's M&A unit and -- to my knowledge -- GE has yet to unveil its big plans in the laundry biz.)
As the next batch of Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan (JPM), Bank of America (BAC) and Citigroup (C) analysts sit in dorm rooms preparing for the riddle that may open or close the gates to Wall Street, I submit there's a better system.
Investment banks should simply ask interviewees to put a value on Facebook (FB).
The riddle of Facebook's valuation seems to me to be a far more productive interview question than an abstract brainteaser. Wall Street has clearly failed at putting together a cogent analysis of the company, and a new set of eyes to the problem may prove helpful.
For instance, on Wednesday, parsing Credit Suisse's assumption of coverage on Facebook's stock at $24 a share showed the bank valued the social network's "blue sky" growth prospects in advertising and mobility at just $4.50 a share, a 60% cut from its initial estimates. Most of the price target cut came from assigning Facebook a 50% chance of being successful in its future mobile and advertising endeavors, instead of certain victory.
It seems initial analysis of "blue sky" opportunities was more like pie in the sky, so why not test newcomers to Wall Street on whether there are better ways to value Facebook? The challenge would be a good test of the skills needed in investment banks and might bring in new ideas.
After lead underwriter Morgan Stanley and a slew of other investment banks priced Facebook's May 18 initial public offering at $38 a share, the company's near 50% stock drop and dramatic variability in published analyst estimates signal a woefully performance in valuing the billion-member plus social network.
When Facebook first went public, average analyst estimates were roughly $40 a share, now they stand at $28.76, according to Bloomberg data. While Facebook's earnings and user growth have decelerated, new-found bearishness also revolves around a rethinking of the company's intangible value, as Credit Suisse's price cut shows.
From the company's IPO bonanza to summer trading lows below $18 a share, analysts like Laura Martin of Needham & Co. have had to backtrack on imprecise initial valuations that relied on the Mark Zuckerberg-run company being an "option on the world." The analyst cut an initial Facebook valuation from $40 to $25 a share, as real numbers took precedent over rhetoric.
Others, like Gene Munster of Piper Jaffray, are sticking with valuations in excess of $40 a share, combing through metrics like click rates and teen engagement for reasons to remain optimistic.
Instead of testing the incoming class of Wall Street analysts on their ability to solve brainteasers under the pressure of a final round interview, banks may simply want reach out to college grads for a fresh take on Facebook's value.
Arguably, it is Henry Blodget, the excommunicated Wall Street internet analyst and Business Insider head, who was most accurate in predicting Facebook's worth and his efforts amounted to a simple back of the envelope analysis that any incoming Wall Street analyst should be able to sketch in an interview.
Secondly, analysts new to Wall Street should be well versed in the challenges of valuing fast-growing and disruptive tech companies. Whether it be equity underwriting, sales and trading, brokerage or investment research, business coming out of newly public Silicon Valley startups are a rare growth opportunity for Wall Street investment banks, which continue to suffer from a sharp drop in merger and trading activity.
In the third quarter, global IPO volume was just $21.3 billion -- the lowest level of stock underwriting since the financial crisis, according to Bloomberg data. Still the numbers show high-growth technology and internet startups are driving whatever IPO activity remains, especially compared with 2011 results.
As the next set of college seniors and juniors brace for interviews to land the analyst gig or internship that will pave a path to Wall Street glory, their time may be best spent trying to run the numbers on Facebook.
For more on Facebook shares, see the calculations of Credit Suisse's price cut and why there's reason to question whether the company was misleading in its IPO disclosure of risks to a mobile strategy.
Interested in more on Facebook? See TheStreet Ratings' report card for this stock.
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