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Facebook IPO $100 Billion Valuation Is Not So Overpriced

February 03, 2012 | About:
When it comes to the largest social networking site, everybody things of one name,Facebook, along with the famous young founder, Mark Zuckerberg. Facebook, from the Harvard dormitory room of eight years ago, is taking its first step to become a publicly traded company, the largest Internet initial public offering ever, with the target valuation of $75 billion to $100 billion – surpassing Google’s (GOOG) IPO in 2004 or Netscape’s in 1995.

Mark Zuckerberg, has detailed the company’s mission and vision in his letter. He said that at first, Facebook was created not to be a company; it was built to fulfill the social mission of making the world more open and connected. He wrote: ”People sharing more – even if just with their close friends or families – creates a more open culture and leads to a better understanding of the lives and perspectives of others. We believe that this creates a greater number of stronger relationships between people, and that it helps people get exposed to a greater number of diverse perspectives... Simply put: we don’t build services to make money; we make money to build better services.”

Several years ago, we were often thinking of Facebook's power over private consumers’ data, and questioning its ability to monetize the site. So the IPO event gives investors the chance to look closer into its financial details. In its IPO filing with the SEC, it is reported to have 845 million monthly active users, 2.7 billion Likes & Comments per day, 250 million photos uploaded per day and 100 billion friendships. It generates rapidly increasing revenue for the last three years, from $777 million up to more than $3.7 billion. The large part of revenue has come from advertising, where it increased from $764 million up to more than $3.1 billion. For the bottom line, the net income grew very fast in three years, from $230 million to $1 billion for now. In terms of cash generation, as fiscal year of 2011, the cash flow from operations is more than $1.5 billion along with the free cash flow of $940 million.

So in terms of multiple valuation, at $100 billion valuation, Facebook is valued at 100x P/E, 106x free cash flow, 67x operating cash flow and 15.8x its book value. The valuation seems extremely high. But is that so? Then we should try to do the inverse discounted free cash flow for Facebook. The valuation of $100 billion would be equivalent to the assumption of 50% growth in its free cash flow for the next five years, and then 5% growth to infinity afterwards, with the discount rate of 10%. Comparing those assumption with the past operating data, the site has generated the consistent rapid increasing free cash flow over time, with the past three years annualized growth of 97.5%, so the assumption of growth for the next five years is nearly half of the past reality.

Year 2012 2013 2014 2015 2016 Terminal value
FV 1,410 2,115 3,173 4,759 7,138 149,901
PV 1,282 1,748 2,384 3,250 4,432 84,615
Valuation 97,711


And in terms of user valuation, the $100 billion with 845 million users would value each user at the worth of more than $118, including their private data posted in Facebook, their photos and their daily life events/comments as well as private messages. Using common sense, would you trade $118 to own the person private data including everything listed above? I personally do not think it would be the ridiculously high figure.

Nevertheless, in technology field, nobody knows what would happen right in the next day. Before, nobody knew Facebook would come along to successfully compete and surpass MySpace. As long as Facebook kept innovating to make better products to keep users coming back in their already built strong network background, it would continue to grow, very fast and gradually becoming the larger and larger social network site and owns larger amount of private users’ data around the world.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 2.8/5 (32 votes)

Comments

tonysf
Tonysf - 2 years ago
.
Jonathan Poland
Jonathan Poland - 2 years ago
Buffett once said that if he taught an investment class a final exam question would be: "How do you value an Internet company? And, anyone who turned in an answer would fail. I am not sure it's changed since then....
ken_hoang
Ken_hoang - 2 years ago
Yes, actually it's the technology company that Buffett is talking about. And Berkshire Hathaway has bought in $10 billion into IBM.. it's all bout the great company at the fair or undervalued price. Just thinking back when Google went public at around $100 at 100x P/E in 2004. And when Munger said about the moats full of shark in Google.

Google is the largest storage information in the world, private data including emails, database, websites etc. For facebook, it is to save the private data, connections, private messages, anything about its users sharing on facebook.
AlbertaSunwapta
AlbertaSunwapta - 2 years ago
I'd like to look to what will people be selling in order to buy Facebook. Any ideas?
batbeer2
Batbeer2 premium member - 2 years ago
Thanks for the article.

Who is selling the stock and why ?
ramands123
Ramands123 - 2 years ago
I like the DCF calculation. Although as value investors we are taught to stay away from IPO's and expectations of high rates of return on these IPO's, but i think it might be worthwhile to evaluate facebook because it has a real moat and solid user base.

mo77
Mo77 - 2 years ago
Anh,

My biggest problem with buying shares in Facebook is that there is no margin of safety.

The idea of 50% YOY growth for the next five years is in my view a bridge too far.

There is no question that Facebook is a great company, but buying a great company at a ridiculous valuation is a horrible idea.

Google is constantly cited, but Google is the exception rather than the rule.

Facebook could also be the next Yahoo or AOL.

I feel that Facebook and all it's mini-mes (linkedin, zynga, zillow, groupon) that constitute the social networking space are the latest fad.

My feeling is ultimately the vast majority of these stocks will incur permanent impairments

once their underlying businesses are re-valued properly.
Burak
Burak - 2 years ago
This is nonsense. Facebook had earnings of nearly 1 Billion $ last year. It had nearly 3 Billion $ in sales. The true value range of Facebook is between 18 and 22 Billion $. Everything above or under this range is unrealistic. I ask myself how people can value without knowing the basics of business. 100 Billion $ in value -> Sorry, but are you "real value" investors?
AriePermadi
AriePermadi premium member - 2 years ago
Warren buffet follower should not touch this stock especially at such price.
mmel
Mmel - 2 years ago


Even with all the well-said comments above put aside, would you be willing to accept only a 10% annual return on this investment (discount rate of 10%) with all of the risk associated with the underlying cash flow assumptions? Let's say you are right about the cash flows, I am not looking for things that are going to return only 10% each year. I could get that from other companies that have much stronger business models. There are just too many other great prices out there to justify holding up money in this stock.
hschacht
Hschacht - 2 years ago
The fallacy of the above article is on full display... look at the size of the terminal value. Assumptions make the world go round. One change in the underlying assumptions and the whole thing falls apart. If the founders of FB are willing to go public (sell... if only in part), why would people be lining up to buy?

What's that old line about playing poker? If you look around the table and you don't know who the sucker is; it's you.

Compile a list of other companies you could buy for $100 billion and compare.

I'd buy DPS (8b) + Loews (15b) + Kyocera (16b) + lexmark (3b) + Janus (less than 2b)

using the excess balance sheet cash from the above + my remaining funds, I'd have enough to buy HPQ ($60b)... that would still leave enough to buy a nice weekend place and throw one heck of a party.

I'd invite all the mutual fund managers at Janus and the HPQ board so I could thank them for their years of service and point them to the nearest employment office.
coda
Coda - 2 years ago
Your resoaning is flawed you're doing your valuation starting from the assumption of a steady 50% growth per year for five years,notwithstanding that risky assumption you're happy with a 10% IRR....

This is exactly what brought us to the Nasdaq bubble.I will quote Klarman who says that betting on a 100% growth rate is just like gambling in a horse race
Sivaram
Sivaram - 2 years ago


BURAK: "This is nonsense. Facebook had earnings of nearly 1 Billion $ last year. It had nearly 3 Billion $ in sales. The true value range of Facebook is between 18 and 22 Billion $. Everything above or under this range is unrealistic. I ask myself how people can value without knowing the basics of business. 100 Billion $ in value -> Sorry, but are you "real value" investors?"

Facebook's earnings and revenues are depressed. With something like 500 million users, it is unreasonable to expect earnings of only $1 billion in the long run. The $100 billion valuation looks frothy but it is probably worth way more than $18b to $22b too.
ken_hoang
Ken_hoang - 2 years ago
Of course Facebook and Google is not the type for Value Investors at its first play, because it was listed at very high multiples. Remember one IT conference for global CEO has stated about the idea of servers per employees, which stores data. Google got like 60 sth servers per employees, and Facebook got 75 servers per employees.. The only assets that Facebook got is the private data of more than 50% people around the world which uses the internet. Do you use FAcebook? and if you do, then all the pictures upload, all the data, comments , private messages you sent.. it all belongs to FAcebook assets.
hschacht
Hschacht - 2 years ago
The idea that millions of pictures of family trips to Disney World and pets are worth billions is absurd.
superguru
Superguru - 2 years ago
"_ The idea that millions of pictures of family trips to Disney World and pets are worth billions is absurd."

I though it was all about getting people to spend time on facebook and then earn money doing targeted advertising or selling game points.

Think of facebook as new interactive media and TV networks as old media and Radio/newspapers as even older media.

Are you saying that stupid soap or reality show on TV is worth more than my Disney trip pics?
hschacht
Hschacht - 2 years ago
Don't be hatin' my soaps now!

I suppose some people spend lots of time on FB, but I suspect the majority are bump and run users like me. If I've been on FB for an hour a month, it would be noteworthy. I get a message from someone and I quickly send them my email. The site is tedious and it will die out just like the others.

What were they again? Oh yeah. My Space... and before that it was AOL. Are they bankrupt yet?
Sivaram
Sivaram - 2 years ago


HSCHACHT: "What were they again? Oh yeah. My Space... and before that it was AOL. Are they bankrupt yet?"

I can see you being skeptical but my personal feeling is that Facebook has a huge moat. I'm planning to write a post about this on my blog (plus other items) but I think it is one of the biggest moats the Internet world has seen. Facebook's moat is probably bigger than Amazon's or Google's!

As people upload more and more of their personal photos, establish stronger connections with friends, start integrating more into their mobile lives, the switching costs are going to be enormous, eventually. Once people are attached to the platform it will become more and more difficult to get them to switch. I mean, just look at the difficulty Microsoft and Yahoo! have in trying to get Gmail users to switch.

Furthermore, unlike MySpace, Friendster, AOL, etc, Facebook is becoming more and more of a platform. Zuckerberg and his team has done an amazing job turning a portal-of-sorts into a platform. People haven't seen the power of the platform. Wait until you start viewing movies (say Netflix or Hulu Plus) through Facebook; or when you start buying goods; or listening to music (say Pandora or Last.FM) through Facebook; and so on. People always talk about traditional software companies building platforms (Microsoft, Apple, etc) but I get the feeling that something like Facebook is a more valuable platform with greater profit potential.

So, although one can never be certain about the future, Facebook appears to have a stronger moat than many other Internet service companies. The difficulty for Facebook will be to ensure strong customer retention as their monetize their assets. There is a potential for customer backlash as Facebook attempts to make more money off customers and that is their next big issue. Facebook will also face some privacy concerns they have to navigate through (kind of like what Google has been facing).

My guess is that Facebook is a reasonable buy at a market cap around $50 billion. It's nowhere near that but this is more of a conservative buy than what the growth investors are going for.
hschacht
Hschacht - 2 years ago
I know. This time it is different. Listen I was an analyst back when AOL had a similar valuation and I remember everyone told me it too had a moat. Facebook CAN'T have a moat... just think about it.

Platform vs.network connecting our mobile lives? I'm going to go out on a limb and say the FB boys think they have a platform that connects our mobile lives.

Call it whatever you want... Is such a thing inherently profitable? A value of $100 billion presupposes growth that lasts forever and profits that they can't hope to generate let alone sustain.

Why do i get the impression that everyone on this site is less than 25 years old?

Forget the Alamo, remember the Internet Bubble! ,,,, if you can.
Burak
Burak - 2 years ago
Facebook is only hot air. I think that only kids are on FB. I spent may be only 10 minutes in 1 month for Facebook. It is bullshit. I read an article written by a psychologue that many people using FB get depressions. So: Would you buy a company like this? I would rather buy Pfizer or Merck.
Sivaram
Sivaram - 2 years ago
HSCHACHT: "Facebook CAN'T have a moat... just think about it."

Why not? I can see someone arguing about the valuation but presupposing that it can't have a moat seems hard to believe. Why do you say it can't have a moat?

Do you think Google has a moat?
batbeer2
Batbeer2 premium member - 2 years ago
deleted - wrong thread
batbeer2
Batbeer2 premium member - 2 years ago
FWIW, I think Facebook has some franchise value. It's not worth $ 100B though.

Come on! You can get Amazon for less than $ 100B. Would you bet on Amazon or Facebook being around in 2022 ?

Burak
Burak - 2 years ago
Does Facebook have a moat?

A moat is only a metaphoric word for something that gives a competitive advantage towards other companies, so that in the normal case the revenues and net income should be higher than those figues of the competitors .

Where is the competitive advantage of Facebook? Nowhere. Only by having an account and posting there or sending messages to others this company like many others in the world of Internet doesn´t have a competitive advantage. Everybody can build a Facebook-like site. The market is free - and especially in the world of Internet people like to copy and paste. So: Do you really think that the ROE of this company is safe against competitors? Hmm. It is only a matter of time. And you will see that this big FACEBOOK is not a serious stock. You dont need to be a value investor, or contrary investor or whatever to understand this. It is the nature of economy where high ROEs will be attacked, and the weak companies - those who dont give a special benefit to the customers - will go down. There is no benefit for users in Facebook, in short term everyone likes it - like i did at the beginning; this is the nature of sensation (You see the pictures of friends,etc.) - but in the long term mind works - this means especially in the case of Facebook: You feel that you waste your time, you feel that you get depressed by the flood of informations and people, you decide to disconnect from the Facebook-World, and turn to the real social world - to Life.
Sivaram
Sivaram - 2 years ago
BURAK: "Where is the competitive advantage of Facebook? Nowhere. Only by having an account and posting there or sending messages to others this company like many others in the world of Internet doesn´t have a competitive advantage. Everybody can build a Facebook-like site."

Everyone can build a similar website but that doesn't mean it's easy to succeed. After all, anyone can build an online retail website like Amazon but no one has succeeded.

My theory on Internet businesses is that they are largely a winner-takes-all market (within their niches). Whoever that dominates social networking (say like Twitter) can easily dominate for the next 100 years.

I'm researching Facebook and I'm getting more and more impressed by the minute. Every photo that someone uploads, increases Facebook's moat. I mean, how many people do you think will want to switch to another site (assuming it was even possible to transfer the photos and other contacts) in the future? Facebook also appears to have massive networking effects like no Internet company I have ever seen (other than Ebay)!!!

BURAK: " It is the nature of economy where high ROEs will be attacked, and the weak companies - those who dont give a special benefit to the customers - will go down."

Agreed. But there is nothing to indicate that there are any other competitors that are anywhere close to Facebook, in terms of customer service, benefits, size of the market, etc. To make matters worse for Facebook's competitors, Facebook is a "free" service. Such markets get harder and harder as every day passes and the dominant player continues to build brand equity and barriers to entry.

Sivaram
Sivaram - 2 years ago




BATBEER2: Come on! You can get Amazon for less than $ 100B. Would you bet on Amazon or Facebook being around in 2022 ?

I don't think Facebook is worth $100B; I haven't done any detailed analysis but my guess is that it is attractive around $40B to $50B.

In any case, Amazon is my favourite company (as a potential investment) but I'm starting to think Facebook is way more powerful. I am just researching Facebook now but I get the feeling that Facebook has networking effects like no other company on the Internet (except ebay). So, as shocking as this may sound, I am almost feeling that Facebook would be more likely to be around in 2022 than Amazon.

Because Amazon is quasi-retail, it has low profit margins and may be vulnerable to disruptions, which are more common in retail industry (where everyone can easily copy others). In contrast, Facebook is more like a media company and if you can establish yourself, you can last a long time -- think about how difficult it was to displace established newspapers, radio, or television broadcast networks.
batbeer2
Batbeer2 premium member - 2 years ago
>> So, as shocking as this may sound, I am almost feeling that Facebook would be more likely to be around in 2022 than Amazon.

If you've done the work and you are comfortable with it, then as far as I'm concerned, you are right ! Not many Facebook bulls out there so you may be on to something.

Should you choose to buy this one, I wish you no luck. Just success.

rgosalia
Rgosalia - 2 years ago
Facebook is a bet on global digital ad spending:

(1) Note how ad $ are spent in the real economy - whether it is newspapers, billboards, radio, television, search engines or social networking. It rises and falls quite in sync with economic outlook (with differing elasticities). The best time to look at ad spending related stocks is when the economic outlook is miserable, which in my opinion isn't today. Google was the cheapest in its trading history in 2008 when it seemed that world was going to end.

(2) Ad $ in the emerging world is spent to a large proportion on traditional media. It's a bit far out before you see digital take over the ad spend from traditional media in countries like India and China.

I prefer to use much safer alternatives. My personal preference to bet on this space is by owning the ad agencies. The top four agencies - Omnicom, WPP, Publicis, and IPG - control 90% of the market. Whether an ad is made for traditional media or for the digital world, one of these four agencies is most likely involved. It's hard to argue against the moat that these companies have. They are highly free cash flow generative businesses, require very little capital (office space that is rented and plastic chairs and tables), and have long runway for growth in the emerging world. Interestingly, only a few months back, all four of them were trading under 10x FCF.

All these new era businesses - Amazon, Netflix, Facebook - are in my too hard to analyze pile.

Disclosure: Long OMC

- Rishi

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