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Facebook's cash flow must match hype to avoid 'dotcom' bubble situation

india Updated: Feb 06, 2012 12:39 IST
Madhavan N

There is a basic rule in the stock market: when valuations run far ahead of current revenues, hope is packaged as hype. That is the situation Facebook is in after it filed for an initial public offering (IPO) of shares last week.

The valuation of the social networking phenomenon, at the expected upper end of $100 billion, is 27 times its current revenues or 100 times its earnings - matching Apple and Google in optimistic pricing. Questions have already been raised on whether the pricing is justified. I would add to the debate by pointing to giants that have already fallen.

The biggest of them is, of course, Yahoo, the horizontal portal that still survives with a market value of around $20 billion - having bravely (perhaps stupidly) spurned a takeover offer from Microsoft. Yahoo had tried to buy Facebook for $ 1billion not so long ago!

In the "dotcom" bubble of 2000 and after, we saw many companies go bust. There was Excite@Home that promised broadband content at a time when Internet bandwidth was barely there.

Then, America Online (AOL), a mere Internet service provider, did a smart thing under CEO Steve Case. Since its market valuations were far too stretched, case simply used stock swaps to acquire media and entertainment giant Time Warner Inc, which is more valued than the giant that swallowed it. After nearly a decade as a part of Time Warner, AOL was spun off again as an independent company in 2009.

Facebook, I think, could watch out for an AOL moment. It has to create the cash or assets to match its valuation. It has been making vital technology acquisitions through last year and has also moved ahead of Yahoo as a leading site for banner advertisements. But it still has a long way to go.

The key point to note is that Google's search advertisements were a path-breaking cash avenue that brought hordes of cash to the company, and that happened much before its IPO. Facebook must now match its hype with assets or cash - preferably the latter.