What is Facebook really worth?

As many of our readers are probably aware, Facebook (FB) is about to come to market in the coming days; this will probably be the largest IPO (Initial Public Offering) of a stock ever. The IPO is estimated to raise approximately $10-$11 billion, valuing the company at between $77 and $96 billion at launch. It may even get to over a $100 billion. To put this into context, if the upper end of this range is achieved, FB will be half the size of Google and would rival the market value of Amazon.com and Cisco Systems Inc.

In the case of FB, the big question on everyone’s lips is, will this hyped-up investment be worth it? In a nutshell, my take would be that it is one thing to “like” FB, but it is quite another to part with one’s cash to invest given the large number of question marks over its revenue model.

Last week, FB were honest enough to warn potential investors that the long term financial outlook of the company could be threatened because there were too many people accessing FB via mobiles or tablets and they had little or no idea at the moment of how to monetize this. In fact, this led FB to alter its filing at the Securities and Exchange Commission to say that if this continued, “Our financial performance and ability to grow revenue would be negatively affected.”

In fairness to FB, they are trying to solve the problem and have, according to the UK Telegraph, launched “its own app store”. However, experts are saying that the change in the IPO is tantamount to a profits warning.

The other major problem that potential investors have is the dual class shareholding structure. This basically lets a 28 year old, Mark Zuckerberg, run the company as if it was still his own private company.

As stated above, FB is hoping to raise nearly $11 billion at the IPO Thursday and expects the share price to be around the $33 mark give or take a couple of dollars. However, also as stated previously, this may get higher as some analysts are forecasting FB may increase that prediction as investors have indicated they want to purchase more shares than the 337 million FB is launching with later this week. This is why the value of FB could well be more than $100 by the end of the week.
The FT wrote a very insightful piece on the company and brought up some of the following interesting points:

- Is FB going to be ubiquitous on the internet? I.e. will it attain the same position on the internet that Microsoft once held in personal computing?
- FB needs to own the social dimension and make it pay.

- Can FB control the digital advertising space, like Google does today?

- In Google, users ask for information on products, so targeted advertising works. Will FB users be happy to be targeted for what they profess to like?

- Running a social network is expensive, with capital expenditures running at 30% and growing.

- Free cash flow returns on assets are strong, but Google’s are twice as high.
On traditional accounting measures, the company does not appear to be listing on the cheap, with a PE of 99 being mooted as a valuation metric. If one looks at Price to Sales numbers, it is estimated to trade on 13-16 Sales, compared with the likes of Google on 5-6. The problem with companies like FB that have explosive growth rates is how does one value these companies? Google was also apparently expensive when it listed, but this did not stop the share price growing by 600% since launch.

On the plus side, with 900 million active users, Facebook is undoubtedly the market leader in social networking. But size alone in the technology space does not always mean success. FB might be large today, but what happens when it is no longer cool to have your mum (or dad, or employer) checking out your profile, not to mention the loss of privacy as advertisers start to target your shopping habits.

The company would argue it does not need to be cool, for once it reaches a certain size it will be irreplaceable, similar to what Google is now to search engines. Should the dream of a monopoly over social networks be achieved, then one could imagine a future where searching for information, reading news, watching television, writing a document or talking on the telephone are activities conducted in the Facebook world. In this scenario, a $100 billion price tag may not be that ludicrous. Facebook money anyone?

Dreams of a controlling the social networking world aside, what does one have to believe today to justify the current valuation?

The FT has done this analysis and has calculated that the business has to become far less capital intensive (inclusive of acquisitions) over time, as Google and Microsoft have done. This can be done but for margins to also stay near today’s level of about 50 percent it would be a big ask indeed. Sales would have to grow at least six fold in this period. The latter is certainly possible. For comparison, when Google had the same revenues as Facebook has now it took just seven years for them to increase another 10 times.

Bottom line, investors will need to take a leap of faith if they are to buy into the Facebook dream. This could indeed be the next Google or Apple, but it could also very well be the next Groupon, down 50% since launch. Caveat emptor!

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]