In two recent posts (here and here) I talked about the value of Facebook shares at the time of and following the IPO on May 18, 2012. As is well-known at this time, Facebook’s IPO price was $38 per share, which valued its 2.7 billion shares outstanding at $104.2 billion.
I did a fairly simple present value analysis In the second post to develop a range of “valuations” for Facebook. The calculations are repeated here for reference.
The valuation range was developed based on the assumption that Facebook could grow at compound annual rates of between 25% and 50% for the next five years and that the shares would enjoy pricing at the price/revenue multiple of about 5x enjoyed by Google.
With growth rates of 30% to 40%, the shares were valued at prices ranging from $13.65 per share to $21.61 per share for a range of discount rates from 11% to 13%. In the first post, I asked the question “has anyone done the math?”
Current Analysts’ Outlook for Facebook Growth
Facebook has now been public for about three weeks. More information is becoming available as analysts begin to follow the stock. At present, according to Yahoo Finance, there are 13 analysts following the company. The average estimate of revenue for calendar year 2012 is $4.96 billion. That would represent significant growth from the trailing twelve month revenues of $3.7 billion at the time of the IPO.
The analysts’ projections are always subject to some interpretation. The average estimate for revenue for 2013 is $6.48 billion, which would represent an increase of 30.6% over estimated revenue of $4.96 billion for this calendar year. Let’s go with these estimates for the following analysis.
For the next five years, the consensus growth estimate is 35.9% compounded. That’s a lot of growth, but let’s assume that it is achieved. Under these assumptions, Facebook’s revenues would grow to $30 billion by the end of 2018, or some 6.5 years from now.
At the end of today (June 8, 2012), Google traded at $580.45 per share, representing a market capitalization (per Yahoo Finance) of $189 billion. The implied price/revenue multiple is 4.73x. Google’s latest twelve months revenues are about $40 million at the present time.
Let’s Do the Numbers Again
Let’s assume further that Facebook will be priced at Google’s price/revenue multiple of 4.73x at the end of the forecast period we are discussing. What does this consensus analysts’ forecast, which is what we are effectively using, say about the present value of Facebook shares?
The assumptions outlined above are reflected in the table. Revenue is assumed to be $4.96 billion in 2012 and $6.48 billion in 2013. From there, revenue is projected to grow at the rate of 35.9% for the “next five years.” We see that with 2018 expected revenue of $30.0 billion, Facebook’s market capitalization would be $142.1 billion at the end of 2018. Assuming that level of future market capitalization, the table reflects calculations of the present value of that future value based on a range of discount rates from 10% to 15%. The calculated present values range from $57 billion to $76 billion. Assuming there are 2.74 billion shares outstanding, this provides a range of present value per share pricing from roughly $21 per share to $28 per share.
Facebook shares closed at $27.10 per share today (June 8, 2012), down some 29% from the IPO price of $38 per share.
Other Takes on Facebook
Analyst Marty Wolf of Gigaom recently compared Facebook’s valuation to that of Apple. Wolf was not attempting to value Facebook with this comparison but to offer perspective on its pricing.
Many people would argue that Apple is the strongest company today. The way it makes money, it almost resembles a bank. But if you applied the Apple valuation on Facebook’s revenue, Facebook would trade at about $12 billion, not $57 billion (as of market close June 6, 2012), down from more than $100 billion on its inaugural IPO date.
Also, if you look at other great companies, such as Oracle, Microsoft or SAP, and their valuations on revenue or on EBIT, those companies trade between $10 billion and $14 billion.
Seeking Alpha has a very recent article titled “Facebook’s Valuation Seems Socially Unacceptable.” The writer compared Facebook against LinkedIn (LNKD), Groupon (GRPN), Zynga (ZNGA), and Pandora (P) according to a number of valuation metrics and found the following (with writer’s disclosure):
To me, it appears that Facebook’s valuation is still a bit lofty, despite the fall from the IPO price of $38. It has the highest price to sales ratio, and a very high price to earnings ratio as well. My advice here is that you short it on the next pop, and we can come back to the name as it goes lower. To me, Facebook’s valuation is socially unacceptable.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I think the investment bankers priced the offering based on how shares of Facebook were trading in the private market and their assessments of institutional demand. I don’t think that revenue growth, margins, risk or any other fundamentals played much of a role in the pricing. I don’t fault them for playing the momentum game, but they played it badly.
By pushing up the offering price to its upper limit and by expanding the offering to allow more insiders to cash out, they broke the spell that momentum casts over investors. It would have happened eventually, but they did not anticipate how quickly the shift would occur.
What are the lessons to take from this mess?
First, don’t assume that bankers, experts and analysts know what they are talking about. When they tout an investment, be especially skeptical if they have a stake in it.
Second, much as it soothes the ego to think that your portfolio setbacks are because of a conspiracy, where large institutional clients make a killing and the individual investors get the crumbs from the table, it is institutional clients who lose the most in bad deals because they have more to lose.
Finally, remember that markets make mistakes, and they can make bigger ones after a meltdown like this one. I would not be surprised if disappointed investors drive the price down to a point where you and I can have the ultimate revenge on Mark Zuckerberg: Buy his company at a bargain basement price and make money off him.
What About the Original IPO Investors?
A large number of investors purchased Facebook shares at the IPO for $38 per share. Suppose they had expected a 10% compounded rate of return on their investment — i.e., the lowest return in the table above. Projecting the $38 per share IPO price out to the end of 2018 at a 10% growth rate suggests they were expecting the stock’s price to be around $70.70 per share at that time. Assuming there are still 2.74 billion shares outstanding, that would imply a market capitalization of $194 billion, or roughly the equivalent of Google today. Assuming the same multiple of revenue as Google today (4.73x), that would suggest that Facebook’s 2018 revenues would be $40.9 billion in 2018, or about as big as Google is today in terms of revenues.
If Facebook achieves the average expected revenues of $4.96 billion for 2012, the compound annual growth in revenues to achieve $40.1 billion in revenues for 2018 would be about 42% for the next six years.
I’ll ask the question I asked in the first post once again … Did anyone do the math?
My own disclaimer is that I am approaching the topic of the pricing of Facebook as a business valuation guy. I am not offering investment advice of any kind, but am simply reflecting on valuation in the news as a business valuation analyst.