I'm waiting for Smurfler and Who-jitsu to file for initial public offerings. Prices for recent IPOs with more recognizable names are high enough to signal a bubble like the one that popped in 2000. All that's missing are a string of firms I've never heard of scrambling to cash in. If Smurfler would hurry up and begin existing, it might be able to raise $300 million in time to pull a Pets.com and blow it all on Super Bowl ads.
Here's a quick guide to evaluating Internet IPOs and a list of seasoned companies that seem to be better deals.
Step 1: Begin with a prejudice against buying a recent IPO. A stock offering, after all, means informed investors are selling part of their stake to any and all comers, and the expectation that its value will skyrocket in coming years is usually not high on their list of reasons for doing so. Not surprisingly, long-term studies show that IPOs tend to underperform the broad stock market over long periods.
Step 2: Determine the market value, or total cost, of all outstanding shares. For companies that are already trading, that's as easy as pulling up a quote on a finance site. For others, you have to explore a Form S-1, used to register new securities. Find it by using an Edgar search site like FreeEdgar.com. (Edgar stands for Electronic Data Gathering Analysis and Retrieval. Think Google, only made by the government, so its motto, instead of "Don't be evil," is "Don't be easy.") Preliminary S-1 forms will list things like recent financial results, and later versions will include the size and pricing of the offering and the total number of shares outstanding afterward. Once you have that, you can figure out the market value.
Step 3: Divide the market value by sales. In doing so, you're comparing a measure that depends entirely on investor excitement with another that isn't affected at all by investors. In other words, you're measuring froth. You can do that with other measures of fundamental value, like earnings, cash flow and asset value, but young Internet firms often operate at a loss, spend more cash than they make and have little in the way of hard assets, so sales are best for the job. Calculate a year's worth. For most companies, you can use the past four quarters, but for ones with explosive growth, simply multiply the most recent quarter by four. For example, LinkedIn, a networking site like Facebook, only with more r sum s and fewer cat pictures, reported sales of $94 million in the first quarter of 2011, more than double what it reported a year earlier. Multiply by four to get $376 million a year. Divide its $9 billion market value by this figure and you get a price/sales ratio of 24.
Step 4: Put the P/S ratio in context. Among the companies in the S&P Composite 1500 index, the median has a P/S ratio of just 1.5. Excluding a pair of drug developers whose sales are expected to jump, no company matches LinkedIn's valuation. Apple, a stellar performer that's popular among investors, has a P/S of 3.6. For LinkedIn to end up priced similarly to Apple, its sales would have to double in each of the next three years. That's possible, but it didn't happen for Google after its 2004 IPO, and Google knows a thing or two about explosive growth. LinkedIn didn't respond to requests for comment. Bank of America, J.P. Morgan and Morgan Stanley, top underwriters on its stock offering, initiated coverage of shares with positive views.
As a general rule, be wary of stocks with P/S ratios anywhere close to double digits. In private share trading, Facebook recently changed hands at more than 30 times its estimated sales, and Twitter, at more than 80 times sales. Both are candidates for high-price public offerings. Groupon, a website offering local, use-it-or-lose-it discounts, mostly on things whose true value is difficult to determine in the first place (half off yodeling classes!), is expected to be valued at more than $20 billion following its pending IPO. That's a comparably modest 15 times sales. But as Groupon acknowledges in its S-1, its sales (the price users pay for deals) are less representative of the value it creates than its gross profit (the cut it gets from merchants). The latter measure would present a ratio of over 30. Zynga, a video game company best known for a farming simulator popular among Facebook users, also looks likely to debut this summer, with a value of more than $20 billion, or 21 times sales.
The table shows some old-economy alternatives with valuations suggesting they could generate good returns in the future. Groupon fans can appreciate the workaday items discounted at Target, which has found new growth from groceries. Facebook is king in social networking, but Google dominates search and sits on more than $30 billion as it gains share in office-productivity software and tinkers with social networking. Simulated farming is loads of fun, I bet, but before paying $20 billion for Zynga, I'd pay a touch less for Archer Daniels Midland. It can process enough wheat each day to make 70 million not-the-least-bit-virtual loaves of bread. Finally, LinkedIn's lead in professional networking seems safe, but I'd hedge by betting on Diageo, a major player in offline social networking and professional-contact management. It makes Johnny Walker, Guinness and other deal-enhancers.
The Real World
These public companies offer alternatives to pending tech IPOs and appealing valuations to boot.
|Sales Growth, Most Recent Quarter (%)||*P/E*||Dividend Yield
|Archer Daniels Midland (ADM)||Food processing||31||19.7||33||9||2.1||0.3|
|Diageo (DEO)||Wine and spirits||82||52.2||2||26||3.0||3.3|
|Google (GOOG)||Internet services||521||16.8||27||16||NA||5.4|
|Target (TGT)||Retail stores||48||33.0||2||12||2.5||0.5|
|Data as of 7/1/11. *Based on forecast EPS for current fiscal year. NA=Not applicable. source: Thomson Reuters|