Face it, the book value’s not so great

Wednesday, 6 June 2012

Here's a very simple quiz. If you want advice on how to lose weight, do you ask a fat person or a thin person? If you want advice on how to quit smoking, do you ask a smoker or an ex-smoker? If you want advice on how to get rich, do you ask a rich person or a poor person?

Phrased this way, the answers are quite obvious, but human nature is very different. So you will frequently see smokers sharing tips on how to give up; you will frequently see obese people at the confectionary counter discussing diet tips; and you will frequently see unemployable people discussing get-rich-quick schemes.

Facebook recently listed on the NASDAQ Stock Market in the US in what has turned out to be one of the biggest initial public offerings in history.

Some 421 million shares in the company were sold for US $38 apiece; raising a whopping $16 billion. This immediately transformed 28-year-old Facebook founder Mark Zuckerberg into the 29th richest person in the world (according to Forbes). I'm very happy for him.

On the other hand, I have no sympathy whatsoever for the idiots who stood in line to put their life savings into this venture. They will never see their money again.

Don't get me wrong. I love Facebook. I've been using the world's most popular social networking site for more than five years. I love it because it has allowed me to keep in touch with friends and loved ones around the world. We share joys and sorrows through words, pictures, video clips. We exchange jokes, and engage in debates on matters both frivolous and earth shattering. Facebook has irreversibly transformed the fundamental underpinnings of human interaction.

How on earth do you make money from it?

In the 12 months prior to listing, Facebook generated about $3.7 billion in revenue. Most of this comes from advertising with about $500 million coming from its share of online games using the Facebook platform.

If you had enough money to buy Facebook out completely, it would have cost you $104 billion. At $3.7 billion per year, it would take you 29 years to make back the money you spent on buying the company before you turn a profit.

Now you could take slightly less money and buy out retailer Amazon.com which is valued at around $97 billion. Amazon's earnings for the first quarter of this year were $13 billion.

Or you could buy slightly less than half of Wal-mart which is valued at around $220 billion. Wal-mart's earnings for the past twelve months was $450 billion.

But that's not the worst; Facebook made less money over the past 12 months than it did in the year prior to that. For the first quarter of this year versus the first quarter of last year, earnings were down 12 percent. If that trend continues, expect that 29 year period to stretch to the next century.

How did so many people make such a dumb investment? It's because most of us make most of our decisions with our hearts and not our heads. We see it in the way in which we vote for our politicians. We see it in the sports teams we support. We see it in our fondness for designer labels priced at 100 times the cost of a no-name brand of the same materials. All of us know someone who uses Facebook, so we assume that that popularity implies financial value.

I'm not a registered financial service company, so I'm not allowed to give you financial advice. I will say this much though; if you want to make a small fortune from Facebook, it's easy – start with a large fortune.