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The Antisocial Valuation: Part II

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Never did I imagine when I posted "The Antisocial Valuation" two weeks ago that I would actually ever get the opportunity to buy Facebook (FB) at a reasonable price. And so soon.

But in a remarkable display of rationality (on the part of a market not always inclined to be so), FB has been leveled fast and furiously -- down to $27 per share, 29% below its $38 IPO price and a shocking 40 percent below the $45 high reached on its first day of trading.

Market prices usually take months or years to properly value economic fundamentals. A 180-degree turn in sentiment in less than two weeks is a rare gift to the value-conscious investor.

The $27 per share puts the market capitalization below $60 billion, net of the new shares issued (and cash raised) in the IPO. The business is probably worth north of $70-80 billion on a discounted cash flow basis -- and not less than $40 billion, even under some very dire scenarios where Facebook devolves into a post-fad, quasi has-been.

As I said in the prior post, Facebook is a great company. Whether or not it ever monetizes even half its 900-million-strong user base, it's already supremely profitable, generates nearly a billion in free cash flow, and sports billions in excess cash from the IPO. FB benefits from the widest of moats given its unprecedented network effect and high switching costs. Even if FB generates only $2 billion in yearly free cash flow by 2015, it should fetch a $70 billion valuation today.

Some worry about the overhang of shares as lock-ups expire, but this has already been discounted by the decline in the stock.

One item that gives me pause is the dual-class structure that grants Zuckerberg absolute control and the rest of us none. He won't win any governance prize for this shoddy arrangement. You could easily trust Warren Buffett with the attendant misalignment -- but not so much the CEO-in-hoodie. The redeeming fact about public companies is you can vote with your feet: If Zuck doesn't put shareholders first, there's always the "sell" button.

What I was unwilling to buy at $45, I finally bought in my fund at $27 a share. Any good business is a good value at some price. The expected return is now high enough to justify the expected risk. At $45 per share, nothing could afford to go wrong. At $27, not much has to go right.