The Day Facebook Becomes a Value Stock

Jonathan Heller
June 19, 2012

NEW YORK (TheStreet) -- As a value investor, there are a plethora of companies that I will probably never own. High-growth companies with high expectations, and cult-like followings are unlikely to ever end up in my portfolio. Unless, of course, they become cheap enough.
Typically, when this happens, the growth crowd has already given up and fled the scene. In that regard, there's sometimes a fine line between growth and value. Sometimes the growth players give up, and the value crowd moves in. In a sense, it's a "circle of life" of sorts in the investment world.
I certainly don't see that happening anytime soon with Facebook FB . I've been asked by many why I was so critical of Facebook in the weeks leading up to the IPO. The truth is, I have nothing against Facebook. I use it and although the novelty has worn off for me, it is still a phenomenon for many. It wasn't the company per se that I had an issue with, it was the valuation. It just did not make sense that the company could be worth $100 billion, which is 100 times earnings, and more than 30 times revenue, right out of the chute. This is a cult stock, and investors are often willing to pay a premium for those, whether or not it makes sense. I still don't like Facebook at $31, which is 50 times 2013 consensus earnings estimates, and about 10 times revenue. I doubt I'd be a buyer at $21, or $15. But that's just me. (That's not to say that no one will make any money on Facebook; that's a separate issue.)
I will, however, look at former high-flyers when the growth crowd finally throws in the towel. That's partially what happened to eBay EBAY in early 2009; of course that was also an extraordinary time in the markets, and many names were simply being thrown away. In eBay's case, the beating was brutal and mostly undeserved. Shares briefly dipped below $10 in early March 2009, which implied a price-to-earnings ratio of less than 6. That was remarkable for a company with net profit margins in the high 20s, nearly $5 billion, or just under $4 per share, in cash and marketable securities, and no debt on the balance sheet. EBay, a high-growth, cult stock I thought I'd never own, became too cheap not to own.
Taking a position in eBay may have seemed like a big step for a value investor, someone who is a follower of Ben Graham. But the valuations were compelling, and eBay had made the leap into the world of value. It was a profitable position too, as the stock more than tripled in less than two years. When I finally felt as though eBay had run its course, I closed the position. It has since run higher. EBay is still not very expensive, trading at about 16 times 2013 consensus earnings estimates, and is still highly profitable (27.7% net profit margins for 2011), but it's not the screaming value play it was a few years ago.
Sometimes former high-flying cult stocks implode and, once the dust settles, if there's anything left, they may be worth a look. Krispy Kreme KKD is a great example. Once the much-heralded IPO (2000) of a well-known brand that was originally founded in 1937, the company's ultra rapid expansion, accounting problems, and bad management decisions in the years following the share sale nearly led to its downfall. Between 2004 and 2009, the company closed 240 stores, and Krispy Kreme lost money for five consecutive years. Class-action lawsuits and near obscurity as a publicly traded company followed. Once a $50 stock in 2003, Krispy Kreme shares bottomed out around $1 in early 2009.
Very quietly, however, and under new management, Krispy Kreme began turning things around. The company reduced debt, and in 2010 reported break-even results and positive same-store sales. This was a much scaled-down version of a former growth story, but one that had value, at least in my view, and I took a position in early 2010. Although earnings weren't much to speak of, there was a great deal of value in the brand, and in the physical locations the company owned. Since then, earnings have improved (there's still a ways to go, though), and the company is once again expanding, but this time around, much of that expansion is coming from international franchises. In fact, nearly two-thirds of the 692 stores are outside the U.S. Interestingly, there are now 87 locations in Saudi Arabia, and plans for 35 in India over the next five years. This is a unique turnaround story, one that is still developing.
The lines between growth and value are sometimes blurry. This can create some interesting opportunities for value-oriented investors. It's too soon to say whether Facebook will get there. But stranger things have happened.
The writer owns shares of Krispy Kreme.