Monday, August 20, 2012

Facebook face plant: Time to friend the company? – By Aswath Damodaran

As Professor Damodaran mentions in the article, he has a limit order out for shares at $18. If you think his valuation is about correct, the heightened volatility in the stock might make it an attractive candidate to sell some cash-secured put options as a way to establish a position. I don’t have any position whatsoever in the stock, but the March 2013 $19 strike price options closed Friday at $3.30 and opened today (before the stock recovered) at $3.40. At that price, your two scenarios if you sold cash-secured put options would essentially be: 1) earning about 21-22% on the cash you reserved in your account (in case they would have gotten exercised) if the options don’t get put to you; or 2) you’d end up owning the shares (if they get put to you) at a net cost of under $16 per share.

If Facebook was over valued at $38, relative to the estimated value of $27/share, is it under valued at $19? To address this question, I revisited my Facebook valuation from May and looked at what I have learned about the company (for the better or worse) since. Has there been enough information that has come out about the firm that could have caused the intrinsic value (at least as I measure it) to drop below $19? The biggest piece of financial information that has emerged on Facebook has been one quarterly earnings report a few weeks ago and it seems to me that not much has changed on either side of the ledger since February. The earnings report was a disappointment to markets, revealing less revenue growth than anticipated and an operating loss, largely as a result of share compensation expenses that were recognized when restricted stock units owned by employees were recognized at the time of the IPO. Facebook remains a company with vast potential (their user base has not shrunk), no clear business plan (is it going to be advertising, product sales or something else) and poor corporate governance. I had not expected any of these issues to be resolved in the one quarterly report and they were not. I did make some adjustments to my valuation: (a) lowering my revenue growth (with my 2022 revenue estimates dropping by about 10%, relative to my May estimates, (b) reducing the operating margin from 35% to 32% to reflect the higher expenses and (c) reducing my sales to capital ratio from 1.50 to 1.20 to incorporate the higher cost of acquisition driven growth. With these changes,  my intrinsic value for Facebook with the updated information is $23.94, a drop of just over 10% from my May 2012 estimate.


Related previous post: Selling Cash-Secured Put Options

Neither I nor any investment product I co-manage have sold puts on the stock(s) mentioned in this article. The company where I work - Chanticleer Holdings, Inc. - has recently launched a registered investment adviser, Chanticleer Investment Partners, LLC. This entity is now accepting outside capital and it will consider selling puts when the situation is attractive, though it has not yet sold any in client accounts as of the date of this post.

This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.