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Facebook’s Value Is No Trick Question

Antoine Gara | Staff Reporter
Thursday, 11 Oct 2012 | 11:03 AM ET

How many ping-pong balls can you fit in a Boeing (BA) 747 jet? What angle is formed between an hour hand and a minute hand on a nondigital clock when it reads 3:15?

The brainteaser — one of the rites of passage for anyone seeking entry into a banking or sales and trading analyst program — can be a make or break moment for an aspiring banker depending on whether one screws up.

Reporters at TheStreet faced quick-answer interview questions in past lives on Wall Street, such as what is 29 x 19? Calculate the number of fire hydrants in New York City ... and how many gas stations are there in America? [Hint: Show a method and some poise in solving the problem like starting with 30 x 20 to make life easier.]

Stump questions sometimes even borderline on the philosophical and the absurd. A friend looking to move into a trading job at Barclays was asked whether they'd rather be a big fish in a small pond or vice versa?

When bidding for an investment banking gig at Lehman Brothers, I was asked to value a proposal by General Electric to buy up a chain of laundromats and detergent companies. Since GE makes millions of washing machines, the interviewer wanted to know how would I go about advising the industrial conglomerate on a plan to add verticals. [I wound up far from Lehman's M&A unit and — to my knowledge — GE's yet to unveil its big plans in the laundry biz.]

As the next batch of Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America, and Citigroup analysts sit in dorm rooms preparing for the riddle that may open or close the gates to Wall Street, I submit there's a better system.

Investment banks should simply ask interviewees to put a value on Facebook .

The riddle of Facebook's valuation seems to me to be a far more productive interview question than an abstract brainteaser. Wall Street's clearly failed at putting together a cogent analysis of the company, and a new set of eyes to the problem may prove helpful.

For instance, on Wednesday, in parsing through Credit Suisse's assumption of coverage on Facebook's stock at $24 a share, the bank valued the social network's "blue sky" growth prospects in advertising and mobility at just $4.50 a share, a 60 percent cut from its initial estimates. Most of the price target cut came from assigning Facebook a 50 percent chance of being successful in its future mobile and advertising endeavors, instead of certain victory.

It seems initial analysis of "blue sky" opportunities was more like pie in the sky, so why not test newcomers to Wall Street on whether there are better ways to value Facebook? The challenge would be a good test of the skills needed in investment banks and might bring in new ideas, in a poor showing from Wall Street.

After lead underwriter Morgan Stanley and a slew of other investment banks priced Facebook's May 18 initial public offering at $38 a share, the company's subsequent near 50 percent stock drop and dramatic variability in published analyst estimates signal a woefully performance in valuing the billion-member-plus social network.

When Facebook first went public, average analyst estimates were roughly $40 a share, now they stand at $28.76, according to Bloomberg data. While Facebook's earnings and user growth have decelerated, newfound bearishness also revolves around a rethinking on the company's intangible value, as Credit Suisse's price cut shows.

From the company's IPO bonanza to summer trading lows below $18 a share, analysts like Laura Martin of Needham & Co. have had to backtrack on imprecise initial valuations that relied on the Mark Zuckerberg run company being an "option on the world." The analyst cut an initial Facebook valuation from $40 to $25 a share, as real numbers took precedent over rhetoric.

Others like Gene Munster of Piper Jaffray are sticking with valuations in excess of $40 a share, combing through metrics like click rates and teen engagement for reasons to remain optimistic.

Instead of testing the incoming class of Wall Street analysts on their ability to solve brainteasers under the pressure of a final round interview, banks may simply want reach out to college grads for a fresh take on Facebook's value.

Arguably, it is Henry Blodget, the excommunicated Wall Street Internet analyst and Business Insider head, who was most accurate in predicting Facebook's worth and his efforts amounted to a simple back of the envelope analysis that any incoming Wall Street analyst should be able to sketch in an interview.

Secondly, new analysts to Wall Street should be well versed in the challenges of valuing fast-growing and disruptive tech companies. Whether it be equity underwriting, sales and trading, brokerage or investment research, business coming out of newly public Silicon Valley startups are a rare growth opportunity for Wall Street investment banks, which continue to suffer from a sharp drop in merger and trading activity.

In the third quarter, global IPO volume of just $21.3 billion was to the lowest level of stock underwriting since the financial crisis, according to Bloomberg data. Still the numbers show high growth technology and Internet startups are driving whatever IPO activity remains and are up sharply compared with 2011 levels, in spite of a general malaise.

As the next set of college seniors and juniors brace for interviews to land the internship or analyst gig that will pave a path to Wall Street glory, their time may be best spent trying to run the numbers on Facebook.

For more on Facebook shares, see the calculations of Credit Suisse's price cut and why there's reason to question whether the company was misleading in its IPO disclosure of risks to a mobile strategy.

—By TheStreet.com's Antoine Gara

Additional News: Where Facebook Is Looking to Grow: COO Sandberg

Additional Views: Could Facebook's Beaten Up Stock Finally Be a 'Buy'?

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