As anyone who was on planet Earth last month knows, the Facebook IPO resulted in a huge valuation for the company. Since its IPO, Facebook's declining stock price has reminded us that with a high valuation comes a responsibility to meet market expectations.

 

As of the close of market yesterday, June 6, 2012, Facebook's value has declined to $57 billion from more than $100 billion on its first day of trading.

 

In our world of IT M&A, when a company has been acquired for an "overvalued" price, we always look at whether the company can earn its premium price through sales growth and how long that would take. For example, when SAP acquired SuccessFactors for $3.4 billion in late 2011, it paid a 52% premium based on SuccessFactors' closing price the day before the announcement. Was SAP justified in paying such a high price for the asset?

 

In the case of SAP and SuccessFactors, we said yes. That's because what a company being sold is worth is based more on what a buying company can do with it than what the company has been able to do thus far on its own. And we believe that SAP can mobilize its relationships with enterprise customers and pave the way for SuccessFactors rapid success and revenue growth.

 

Investors clearly are skeptical that Facebook can live up to its current market cap anytime soon. They are asking - rightly so - "We know that Facebook employees and existing investors got rich last month - but what's in it for me as a new investor?"

 

That chapter has yet to be written. But the high premium of the Facebook IPO has put an undue burden on the company management.

 

It is a lesson on why the right valuation is critical in buying or selling a company. And, a premium is worth it at the time of purchase if the purchased asset can meet the valuation expectations.

 

We wrote about this in more detail in a post on GigaOM. 

 

 

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