Investors care about marginal returns. An additional $1 invested into Ford won't bring as much returns as an additional $1 invested in Facebook.
Ford's is a capital-intensive business. That's what gives it hard assets that make its market cap 70% of assets (btw, the author totally forgets the liability side of equation - equity investors aren't owed assets - they are owed (assets - liabilities) - look at big banks, they have trillions in assets - but they have equally enormous liabilities too).
"An additional $1 invested into Ford won't bring as much returns as an additional $1 invested in Facebook."
I don't know what investment opportunities Ford has, but regarding Facebook, I really don't think they can invest additional capital sensibly. An additional $1 invested in Facebook will end up being an additional $1 paid for some Instagram-like acquisition.
Furthermore, additional $$ spent on Facebook IPO stock will just end up an additional $$ in the founders' pockets.
And the reason they're allowed to earn money is that their capital produces more value than it's worth. The only way that can happen in an efficient market is by taking risk. If you don't want any risk don't invest in the stock market.
Yes. Investors believe Facebook's value perception will catch up with its reality, since they are currently out of whack. They believe the current imbalance is in their favor. It's the only way to make money investing.
Ford IS more valuable that facebook. This guy's analysis is an apples to oranges comparison. Ford has $100.5 billion in debt and facebook has no debt - the companies should be compared based on enterprise value:
Enterprise value in billions = market capitalization + debt - cash
FB could just as easily issue debt in billions and I'd think that the market will be valuing it higher than that of Ford's for the same issue coupon (which just came back into the investment grade club after residing in the junk club for quite a while). FB would probably have a good income-to-interest coverage ratio if it ever issued debt so the discounting of its debt's cashflows would be less severe than that for Ford.
I will take a look at the book value of Ford's debt tomorrow on Bloomberg. I agree that the market value of debt should be used for the analysis, but I don't think it will change the conclusion.
It will. Issued debt rarely ever trades at 100 (except in special cases - ie debt near maturity etc).
And, in any case, you cannot compare market values of two companies with different leverages such as FB and Ford without renormalizing earnings to the same leverage level. Earnings on equity are amplified if the company has debt (which Ford has). FB has no leverage - its unleveraged earnings give it a whopping market value of $95B. Ford can't even manage half of that figure with its $100B (!) of debt.
Issued debt typically trades near par (100) unless the borrower's credit rating has changed or interest rates have changed (both of which happen all the time, but still, the vast majority of debt trades in the 90-110 range.)
You can compare two companies with different levels of leverage. They both have Enterprise Value (EV), which is normally calculated as operating income (EBITDA to be precise) * a multiplier. Market capitalization, or equity value, is by definition the different between the EV and the net debt (debt - cash). (P/E ratios are usually not as useful as the EV/EBITDA approach for understanding a company, btw.)
One company may be highly debt financed and the other may be pure equity financed. As you say, debt financing supercharges equity earnings (see below), but this comes at a higher risk. And in principle, the higher earnings are balanced out by the higher risk and therefore enterprise value is unchanged.
What is a bit harder is comparing two companies in entirely different industries, like Ford and FB!
Equity returns are supercharged by debt because in a growing company debt coupons are cheaper than equity returns. e.g., say you invest $100 to build a company that makes $20 a year. You get a 20% equity return. But imagine you invest $50 and borrow $50 to build a company that makes $20 a year. Your debt pays a typical 5% coupon, so you pay 50*5% = $2.5 in interest. The remaining $17.5 goes to your equity and you get a 35% equity return. BUT if you're unlucky and your earnings are delayed one quarter, it's the bank that gets your 35% equity return cuz you bankrupt, sucka.
"...but still, the vast majority of debt trades in the 90-110 range."
That's usually for freshly issued/on-the run or about-to-mature debt. It _used_ to be the case before the financial crisis that most debt traded near par - that has changed as the cost of repo financing has become disjoint of the risk-free rate since the crisis.
EV/EBITDA is the multiple to compare - as you rightly pointed out. A naive EV comparison, as done by HackerCapital, is misleading.
The description of leverage is also a bit simplified - typically, you would discount earnings with the weighted average cost of capital (WACC) = (cost of debt)(debt/EV) + (cost of equity)(equity/EV). So the discount factor does not simply "balance out" the leveraged (and volatile) returns - it depends on the relative cost of debt vs. equity _and_ the leverage ratio.
It's in the (cost of equity) factor that you can normalize different sectors as (cost of equity) = risk_free_rate + historical_beta * (sector_return - risk_free_rate). Sector return would typically be from a benchmark equity index specific to the industry - whether tech or autos.
I checked and almost all of Ford's securities trade at or above par, so the market value of Ford's debt is higher than I presented above. When I was doing the research, I noticed that Ford has Corporate Debentures that were issued in May 1997 and come due in May 2097!
Exactly - and if FB issued debt - it will trade higher than that of Ford's (with the implicit assumption that FB is a better credit name than Ford).
Those debentures are usually used to finance pension liabilites. I am not sure if corporates are still issuing debt with that kind of duration anymore after the crisis :)
There are many other intangible assets that produce money but are not easily sell-able: Trademarks, human capital, trade-secrets, other intellectual property, etc.
All of these would be in Ford's side without any doubt. Maybe profit-per-capita is the single benchmark they'd clearly lose at, and the fact that their workforce is largely unionized, which is a serious risk in times of hardship (they'd find themselves unable to cut expenses significantly, as it has happened many times in the past).
Ford vs Google might be a close one in terms of IP - hard to compare across industries though - but vs Facebook it's quite one-sided for Ford.
You are correct these things can be viewed as assets. However, if the author is deriving his data from Facebook's own declarations, then even they aren't claiming the value of their assets including User-loyalty, are anywhere near their market cap.
Auditors would stick to the the accounting standards and conventions to give a monetary value to users and other intangible stuff. Whereas the market (in theory) can value the whole company's ability to use these intangibles to generate money in the future. That's why there's often a significant difference between the "assets - liabilities" on the balance sheet, and the market cap. Now, whether such a big discrepancy is justified... that's another thing.
Under GAAP, there are a lot of intangibles that are not reported on the balance sheet. Basically all of facebook's internally developed intangibles are not on the BS, but all of Instagram's intangibles will be there. Kind of weird, but this is how purchase accounting works.
The OED doesn't know your social connections, your sexual orientation, your date of birth, your address, your previous address, your current location, your gender, your age, your interests, your employer, all the websites you've visited or even what you look like.
So, they have good information for advertising. And that's going to valuable, no doubt...
...but that's it. They aren't building a physical product, they're going to sell other people's products. Or, sell information so that other people can sell other people's products.
I find it absurd that the market for web based adverting, between Google and Facebook and others, can be this valuable in the long run. These are advertisers, for crying out loud. People can talk about how many users Facebook has, but there are more automobiles worldwide than there are Facebook users.
What is worth more; a car purchaser, or a Facebook user?
NBC Universal has done pretty well with an advertising funded business model, very valuable for a long time. Facebook does have a product. It is just intellectual, not physical. Also, they have good information, AND a stage to sell advertising. This is, and will continue to be, a killer combo that I would want my money in.
Also. We don't know what is in the pipeline for the future.
Who would have thought Google would build a dominant Mobile OS? Even Google didn't know!
Also it's good to note that their are companies being built on top of Facebook. Zynga is an obvious one but there are many smaller game companies, ad companies..ect and Facebook takes a cut of all of these
There are 76 countries that have "unavailable" information, meaning the metric is based off of registered vehicles, somehow. Really, no one drives a car in Cuba? I've been there, and there are cars. Somalia? Well, I watched Black Hawk Down, and they had cars there too. There are far more cars than that number. I've seen the estimate at a billion:
> What is worth more; a car purchaser, or a Facebook user?
You're talking like the answer to this question is obvious. People will keep cars for 10 years, and they're as likely as not to get them from Toyota instead. At this point, Facebook is probably making a little bit of money (indirectly from Ford advertising) from that car purchase. Not as much as Ford, sure, but Facebook extracts a little bit of revenue from many, many consumer transactions.
The difference is that Facebook is "threatened" by an intangible, hypothetical competitor who doesn't exist yet. Nor does the mechanism for defeating Facebook appear obvious or inevitable.
Whereas Ford faces very real, present competition in a market full of extremely competent players.
Advertising is not nearly so effective as to warrant such a high value for a facebook profile. I'd put a week's pay that, in retrospect, we'll see Facebook's IPO as the beginning of the bubble's pop.
Certainly what makes Facebook valuable is their huge network which is sustained, I think, through barriers to entry (network effect), and barriers to switching (owning your data).
I wonder what might happen, if it could happen that the EU or US FTC mandates api access into and out of Facebook, perhaps after a decision that 2015 Man will use social networking as a needed public infrastructure, to be provided on a common carrier like basis.
Can the sheer size of Facebook's network trigger monopoly break up? Or the sheer size combined with lack of API access?
Facebook does make it surprisingly easy to get a copy of all your data. There's a single big button on the site which will make a ZIP file containing all your data on Facebook, except for data stored in Apps (outside of FB's control), and comments you've made on other people's posts. It will even tell you your previous IP addresses and I think auth tokens.
I'm thinking more of API access so that external apps can be created to link Facebook to other networks, so that tweets and google plus and tumblr posts and all that stuff can just flow from one network to the next like telephone calls can do now.
I just clicked on "Start my archive", Facebook will email me when they are done zipping it up.
Valuation lower than assets means you get eaten by corporate raiders, unless you're as big as Ford or the majority of the stock is held by a single family. That just shows how unhealthy Ford is.
That's not true. Ford is more than $100 billion in debt. If a corporate raider were to take over Ford, they would be saddled with a ton of debt too, making such a takeover a much less attractive option.
Yes, there is :). Take equity control of the company (which should be cheap enough for a badly-doing company) - now you'd have control over the financing decisions of the company. Issue "junior" debt uncollateralized by the company's assets. Use the cash so raised to buy off "senior"/"secured" debt outstanding in the market. When the company goes into bankruptcy, you get the first cut on the assets :).
PS: Actually it's not so simple - when the company is highly leveraged, existing bondholders often do have a say in future financing decisions of the company.
Suppose that someone is able to buy up enough of your stock to essentially own your company, and they notice that the cost of doing so is less than the value of all of the things your company owns. Someone could make a profit by buying your company and then butchering it, keeping a few prime cuts for itself and selling off the rest.
This doesn't happen if the raiding company can't put together enough money to make the purchase, or if not enough of the stock holders are willing to part with their shares.
Its just a 6 minute interview with the CEO (the guy who came in and saved the company from near-bankruptcy) and is now pushing to make Ford an investment-grade stock.
Quite a feat. I think a big key to Ford's comeback is, like you said, enabling engineering to drive the company forward. It probably helps that Mullaly was once an engineer himself.
These two businesses are in entirely different industries. Not only that, they have very different market characteristics.
Ford is a capital intensive industry that reminds me of Berkhire Hathaway - the textile company that Warren Buffett could never figure out how to make money from. It has competitors everywhere making relatively undifferentiated products.
Facebook on the other hand, is more like a media company. It has 1 billion eye balls who spend an average 30 minutes a day on its site on user-generated content. If you were a TV station, how much would you be valued at with that kind of metrics? FB has a beachhead in the sense that it is a marketplace of users who create content, and users who view them. This makes it incredibly sticky and also difficult for a competitor to come about. The downside with FB is that audiences can be fickle. If they think FB is a fad, they will start leaving. Therefore, FB had to establish itself as a habit-forming medium, like e-mail, so that people constantly reengage with it.
> You forgot one important thing: Potential for Growth
The key to understand this madness is so right in front of our faces, that we can't even see it.
Due to the dynamics/nature of the market, stock investments seems to be more about a gamble today, and you can't gamble on Ford too much except for it to go down.
Forget trying to spot the value. It's all about what's hot.
That's how I used to feel too until I read more economic history. Turns out, that's the way it's always been. At the end of the day, stock prices are 100% driven by supply & demand (beside the IPO price I suppose).
Sure, fundamentals are what a lot of people base their buying or selling off of, but what's "hot" is all that matters just like it always has. Maybe a company just crushed their numbers for the quarter or a drug company attained a new patent; and while that may contribute to the true value of the company, when it comes to the stock price nothing matters except how many people buy.
> You forgot one important thing: Potential for Growth
The problem arises when that growth occurs but instead of the price now being reasonable at those levels, it increases further...which is probably what it's going to do.
This is why investing in stocks is also called speculation, investors are speculating that Facebook's revenue and profit is going to grow to exceed that of Ford in a reasonable amount of time.
But we know that the auto industry is cut throat and low-margin. Paying $30K for a Ford doesn't mean Ford just made $30K. Between manufacturing, R&D, marketing, and raw customer acquisition cost (dealerships aren't free), I'd be surprised if Ford walked away with 5% of that.
I've heard so many people talk about buying Facebook "as soon as I can get in". I think that's ridiculous. When it comes to individual stocks, buying or selling without concern for price is for suckers. That's what got us into the last bubble (or few): people who would buy something (like a house) regardless of the price based on an obscene overconfidence that it would appreciate.
I have no idea what the thing's worth, but I cringe when I hear people talking about how they're sure it's a good bet because of some X which is almost certainly already priced into the market.
People still feel like that about investing in land and houses (where I live at least) - they are seen as an investment that is never going to be a bad one (freqently comparing this to renting a place to live).
Hype is what drives anything up. You just have to get out before the hype dies. The problem is that most people ("suckers" as you call them) get in late and don't get out in time.
This is just the market saying "I'd rather see what Facebook can do with X billion than Ford."
Which on the face of it seems fair - Google had a similarly crazy PE when they floated. They grew into it pretty quickly though.