Facebook’s IPO will be way overvalued

An earlier version of this column incorrectly reported the average price-to-sales ratio of IPOs comparable to Facebook.

CHAPEL HILL, N.C. (MarketWatch) � Another Google?

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Don�t hold your breath.

At its anticipated IPO later this year, Facebook will be three times more expensive than Google GOOG � was at its IPO � and nearly 40 times more expensive than the average large IPO of the last four decades.

Those at least are the conclusions I drew from an interview Tuesday afternoon with Jay Ritter, a finance professor at the University of Florida, who is one of academia�s leading experts on the IPO market.

The valuation metric that Ritter chose to focus on is the price-to-sales ratio (PSR). Of course, it�s too early to know for sure what Facebook�s will be when it comes to market, since its offer price hasn�t been set. But, based on the early reports that Facebook will be valued at its IPO at as much as $100 billion, and 2011 revenues of $3.8 billion, Facebook�s PSR will be around 26.

To show how much higher that is than those of comparable new issues over the years, Ritter analyzed his extensive database of IPOs in the U.S. since 1975, four decades ago. Motivated in part by his prior research that found that the smallest IPOs did markedly worse than the largest ones, on average, Ritter focused only on those whose market caps when they went public were at least $400 million in 2011 dollars.

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That�s still not a very high hurdle, and is just 0.4% of what Facebook�s market cap is estimated to be at its IPO. Still, it eliminated the majority of IPOs from Ritter�s database, leaving 1,308 firms.

At my request, Ritter then narrowed his focus even more to just those firms whose trailing 12-month sales as of their IPO were at least $3 billion (again in 2011 dollars). The reason to do that: Some of the companies with larger IPOs had minimal revenue when they came to market, which meant that their PSRs were close to infinity � and therefore meaningless.

Ritter�s resultant database contained 76 large IPOs from companies with relatively established revenue streams when they came to market. Their average PSR as of their initial offering dates: 1.0.

You read that right. Facebook�s estimated PSR is 26 times greater than the average of these comparable companies.

In fact, there is no other IPO among the 76 in Ritter�s subset that even came close. The one with the highest PSR at IPO was AT&T Wireless, which came to market in early 2000; its price-to-sales ratio then was 8.9 � about one-third as much as Facebook�s is estimated to be.

Google, to which Facebook is being compared, had a PSR as of its IPO of 8.7.

The bottom line? To produce a profit stream that is great enough to support a prayer of its stock doing even close to as well as Google�s did in its first few years of life, Facebook�s revenue growth will have to be several orders of magnitude greater, or have a profit margin that is several times greater � or both.

Those are not impossible goals to achieve, but they certainly look like long shots. Is that really how you want to bet with a big chunk of your money?

The bottom line? It�s difficult to avoid the overwhelming conclusion that Facebook, at its IPO, will be way overpriced.

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