Facebook’s poor IPO doesn’t change the fact that it is a good business

By June 8, 2012 4 Comments

There is quite rightly a lot of chat at the moment about Facebook’s poor showing post IPO, but the fact that the shares are down 30% doesn’t mean that Facebook is a bad business, it means that investors now think the $100bn IPO price was too high. 30% to high to be precise.

A couple of pointers on the underlying health of Facebook’s business:

In short Facebook is loved by its customers and is making good profits. There is no evidence that either of these two facts are changing and unless they do Facebook will continue to be a valuable business.

The problem lies in assessing exactly how valuable. Analysts seeking to put a price on young fast growing companies have to make assessments about the future that involve a lot of guess work and everyone knows that their conclusions may turn out to be wrong. That is why the valuations of companies are so hotly debated. When a company like Facebook IPOs the price is set by a process of consensus building amongst analysts and investors in the IPO, and whilst the fact that many parties agree on the price gives comfort it doesn’t alter the fact that everyone knows the price may turn out to be the wrong price. When the IPO is at a high valuation then the nervousness is intense and when the consensus collapses everyone runs for the hills. That happened at Facebook and has had the knock on effect of undermining confidence in the valuations of other fast growing internet companies (thanks to Alan Patrick for the chart).

Falling share prices create challenges for these businesses for sure, but their fundamentals remain the same.