valuing facebook: hype and...
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VALUING FACEBOOK: HYPE AND FUNDAMENTALS, Valuation Strategies
(WG&L)
PUBLIC OFFERINGS
VALUING FACEBOOK: HYPE AND FUNDAMENTALS
While the financial world debates the handling of Facebook's much anticipated and
heavily publicized IPO, the use of several different valuation methods illustrates that
the offering may have suffered from unduly high growth expectations.
Author: CHARLES J. RUSSO AND JAMES A. DIGABRIELE
CHARLES J. RUSSO, PhD, CPA, CMA, CVA, is an assistant professor in the
Department of Accounting at Towson University, Towson, Maryland. JAMES
A. DIGABRIELE, PhD/DPS, CPA/ABV/CFF, CFE, CFSA, FACFEI, Cr.FA, CVA, is
an associate professor in the Department of Accounting, Law, and Taxation at
Montclair State University, Montclair, New Jersey.
There has been much discussion in the financial world regarding the Facebook IPO and the
subsequent drop in the company's share price. On Friday, 5/18/2012, Facebook went public at an
IPO price of $38 per share. Over 576 million shares of Facebook were traded, which set a record
for a new publicly traded stock hitting the U.S. market. At a price of $38 per share, the total
market value of Facebook came in at $104 billion. With 2011 earnings of $1 billion, the price to
earnings multiple was 104 times earnings, which seemed high compared to companies such as
Google (priced at 18 times earnings) and Apple (14 times earnings). Google and Apple are more
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mature companies, and it appeared inevitable that the Facebook stock price would return to earth
at some point. Facebook opened at $42 per share, and the stock proceeded to close at $38.23 on
the first day of trading. The stock price then declined to $25.87 on 6/5/2012. These fluctuations in
the price of Facebook stock are captured in Exhibit 1.
Exhibit 1. Facebook Stock Prices
The decline has left IPO investors crying foul, and a class action lawsuit was filed against Morgan
Stanley, Bank of America, Barclays, and Goldman Sachs for overpricing the stock. According to
standard industry practice, the estimates of analysts are not made public until 40 days after an
IPO. The suit makes allegations that:
Facebook told the underwriters to reduce their 2012 revenue estimates.
This information was only disclosed to preferred investors.
This information was omitted from the registration statement and prospectus. 1
Morgan Stanley fired back stating that “Morgan Stanley followed the same procedures for the
Facebook offering that it follows for all IPOs. These procedures are in compliance with all
applicable regulations.” 2 Morgan Stanley also noted that a revised SEC filing was released by
Facebook on 5/9/2012 prior to the IPO, which provided additional guidance with respect to
business trends, and that the revised information was forwarded to investors and widely
publicized in the press.
3
However, just three days before the IPO, the company CFO David Ebersman increased the
number of shares to be sold. This key decision may have sent Facebook's shares downward after
the IPO. At the same time, the IPO price was raised to $38 per share. Large investors—including
Mark Zuckerberg, Goldman Sachs, Accel Partners, and DST Global—proceeded to dump shares
early and cash out before a significant drop in the stock price occurred. For example, Ebersman's
decision helped Goldman Sachs by allowing Goldman to sell up to 28.7 million shares instead of
13.2 million shares. 3 Similarly, DST Global was able to sell 45.7 million shares instead of only
26.3 million shares. When all these additional shares hit the market in the IPO, it may have
exhausted buyer demand with a resulting drop in the stock price for the street investor. Thus,
these large investors made a bundle of money while the street investor watched the value of the
stock drop.
Facebook has two classes of common stock:
(1) Class A, which has one vote per share.
(2) Class B, which has ten votes per share.
The Class A shares were the shares offered in the IPO, but Zuckerberg retains more than 50%
voting control of the company through the Class B shares. 4 The decision by Ebersman to
increase the number of shares may have been quite forward looking, if he had been anticipating
and trying to manage massive sales of Facebook stock by existing shareholders. While the
market was flooded at the time of the IPO, with the company brokering deals with big private
equity and hedge fund investors for early employees seeking to cash out their unconventional
restricted stock units (which the company gave to employees as a way to avoid SEC rules that
require corporations with more than 500 investors to file financial statements), the potential was
looming for the sale later in the year of more than 1 billion shares of Facebook stock when early
investors are freed from lock-up provisions. 5
Analyst Reports
Analyst reports from at least 17 securities firms were released 40 days subsequent to the IPO, on
6/27/2012, following the government-mandated quiet period. According to Bloomberg, 6 18
securities firms analyzed Facebook, with an average analyst share-price estimate of $37.95 per
share. Morgan Stanley, JP Morgan Chase, and five other firms gave Facebook the equivalent of
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a buy rating. Eight firms, including Credit Suisse and Citigroup, had Facebook rated as a hold,
and one firm had Facebook rated as a sell.
According to analysis provided by NASDAQ, 7 the analyst reviews are mixed. The consensus 12
month target price is $39.50 per share. There are 24 analyst firms listed on NASDAQ including
Bank of America, J.P. Morgan, and Barclays. On 7/13/2012, 12 analysts rated Facebook a strong
buy, two rated it a buy, 11 rated Facebook a hold, and two rated the stock a sell. The stock price
on that date was $30.72 per share. 8 The Wall Street Journal listed a summary of 18 analyst
ratings on 6/28/2012, which is provided in Exhibit 2. 9 The lowest analyst price target was BMO
Capital Markets at $25.00 and the highest analyst price target was J.P. Morgan at $45.00.
Goldman Sachs rated Facebook a buy with a price target of $42.00. Note that a price target is the
price an analyst believes the stock should be valued at over a 12- to 18-month period.
Exhibit 2: Analyst Ratings for Facebook
Bank Analyst RatingPrice
TargetBarclays Anthony DiClemente Equal-Weight $35.00
BMO Capital Markets Daniel Salmon Underperform $25.00
BofA-Merrill Justin Post Neutral $38.00
Citigroup Mark Mahaney Neutral $35.00
Cowen & Co. Kevin Kopelman Neutral N/A
Credit Suisse Spencer Wang Neutral $34.00
Goldman Sachs Heather Bellini Buy $42.00
J.P. Morgan Doug Anmuth Overweight $45.00
Lazard Capital Markets William Bird Neutral N/A
PacificCrest Evan Wilson Sector Perform N/A
Piper Jaffray Gene Munster Overweight $41.00
Raymond James Aaron Kessler Market Perform N/A
RBC Capital Markets Andre Sequin Outperform $40.00
Stifel Nicolaus Jordan Rohan Hold N/A
Wells Fargo Jason Maynard* Outperform $37.00
William Blair Ralph Schackart Outperform N/A
Morgan Stanley Scott Devitt Overweight $38.00
Oppenheimer & Co. Jason Helfstein Outperform $41.00
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Risk Factors in Facebook's SEC Registration Statement
In the SEC Registration Form S-1, Facebook listed multiple risk factors for the company and
stated that investors should carefully consider these risks before making an investment. 10 Some
of these stated risks include:
“If we fail to retain existing users or add new users, or if our users decrease their level of
engagement with Facebook, our revenue, financial results, and business may be
significantly harmed.”
“If we fail to retain existing users or add new users, or if our users decrease their level of
engagement with Facebook, our revenue, financial results, and business may be
significantly harmed.”
“We generate a substantial majority of our revenue from advertising. The loss of
advertisers, or reduction in spending by advertisers with Facebook, could seriously harm our
business.”
“Growth in use of Facebook through our mobile products, where we do not currently
display ads, as a substitute for use on personal computers may negatively affect our
revenue and financial results.”
“Facebook user growth and engagement on mobile devices depend upon effective
operation with mobile operating systems, networks, and standards that we do not control.”
“We may not be successful in our efforts to grow and further monetize the Facebook
Platform.”
“Our business is highly competitive, and competition presents an ongoing threat to the
success of our business.”
“Improper access to or disclosure of our users' information could harm our reputation and
adversely affect our business.”
“Our business is subject to complex and evolving U.S. and foreign laws and regulations
regarding privacy, data protection, and other matters. Many of these laws and regulations
are subject to change and uncertain interpretation, and could harm our business.”
“Our CEO has control over key decision making as a result of his control of a majority of
our voting stock.”
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“The loss of Mark Zuckerberg, Sheryl K. Sandberg, or other key personnel could harm
our business.”
“We anticipate that we will expend substantial funds in connection with tax withholding
and remittance obligations related to the initial settlement of our restricted stock units
(RSUs) approximately six months following our initial public offering.”
“The market price of our Class A common stock may be volatile or may decline, and you
may not be able to resell your shares at or above the initial public offering price.”
The company also noted that substantial blocks of their total outstanding shares may be sold into
the market as certain lock-up periods end, and that if there are substantial sales of shares of
Facebook common stock, the price of the Class A common stock could decline.
Facebook's Business Model
Facebook relies heavily on advertising revenue including internet display ads. Advertisers can
direct ads to subsets of Facebook users based on demographic factors and specific interests they
have chosen to share with the company such as age, location, gender, or likes. Facebook allows
advertisers to select relevant and appropriate audiences for their ads, ranging from millions of
users in the case of global brands to hundreds of users in the case of smaller, local businesses.
Internet users, however, generally view display ads as a negative part of their online experience,
and such ads are not very efficient at generating revenues. The loss of advertisers, or reduction
in spending by advertisers with Facebook, could seriously harm the company's business.
In its Form S-1, Facebook notes that a substantial majority of the company's revenue is currently
produced from third-party advertising. Advertising accounted for 98%, 95%, and 85% of
Facebook's revenues for 2009, 2010, and 2011 respectively. Advertisers generally do not have
long-term advertising commitments with Facebook, which is common in the industry. Many of the
advertisers do not spend a significant portion of their advertising dollars on Facebook. Facebook
also states that “in addition, advertisers may view some of Facebook's products, such as
sponsored stories and ads with social context, as experimental and unproven. Advertisers will not
continue to do business with us, or they will reduce the prices they are willing to pay to advertise
with us, if we do not deliver ads and other commercial content in an effective manner, or if they
do not believe that their investment in advertising with us will generate a competitive return
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relative to other alternatives.” 11 Facebook's business is highly competitive, and competition
presents an ongoing threat to the success of the company.
The graphics in Exhibit 3 show worldwide monthly active users (MAUs) and daily active Facebook
users. 12 Facebook has 845 million MAUs, 2.7 billion likes and comments per day, and 250 million
photos uploaded per day. Facebook's 845 million MAUs at 12/31/2011 is a 39% increase
compared to the 608 million MAUs at 12/31/2010. Facebook also had 483 million daily active
users at 12/31/2011, which is a 48% increase from 12/31/2010.
Exhibit 3. Facebook Monthly and Daily Active Users
Facebook is also a platform for developers. There are development tools and application
programming interfaces so developers can integrate with Facebook. Facebook states its mission
is to make the world more open and connected.
Tracking Facebook's Revenue and Earnings Growth
Facebook has seen enormous revenue growth over the past few years, and investors buying
shares at $38 apparently were expecting the growth trend to continue. Facebook's sales revenue
increased by 150% from 2009-2010 and by 90% from 2010-2011. Sales were $777 million in
2009, $1.974 billion in 2010, and $3.711 billion in 2011. The company's sales growth is illustrated
in Exhibit 4.
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Exhibit 4. Facebook Sales in Millions
Net income was $229 million in 2009, $606 million in 2010, and $1 billion in 2011. Net income as
a percentage of earnings has ranged from 27% to 31% over this time period. Cash flows from
operating activities were $155 million in 2009, $698 million in 2010, and $1.549 billion in 2011.
Total cash flows were $336 million in 2009, $1.152 billion in 2010, and $(273) million in 2011. The
drop off in total cash flows in 2011 was largely due to $606 million in purchases of property and
equipment, and $3.025 billion in purchases of marketable securities. Exhibit 5 summarizes
revenue, net income and EPS for the company from 2007-2011.
2007 2008 2009 2010 2011
Revenue 153$ 272$ 777$ 1,974$ 3,711$
Net Income (138)$ (56)$ 229$ 606$ 1,000$
EPS
Basic (0.16)$ (0.06)$ (0.12)$ 0.34$ 0.52$
Diluted (0.16)$ (0.06)$ (0.10)$ 0.28$ 0.46$
Proforma EPS
Basic 0.49$
Diluted 0.43$
Year Ended December 31
(in millions, except per share data)
Exhibit 5: Facebook Revenue, Net Income, and EPS
Full versions of the financial statements are in the SEC S-1 Registration Statement. The
consolidated statements of income for 2009-2011 are presented in Exhibit 6. 13
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Exhibit 6. Facebook Consolidated Statements of Income
(In millions, except per share amounts)
Year Ended December 31,
---------------------------
2009 2010 2011
---------------------------
Revenue $777 $1,974 $3,711
Costs and expenses:
Cost of revenue 223 493 860
Marketing and sales 115 184 427
Research and development 87 144 388
General and administrative 90 121 280
Total costs and expenses 515 942 1,955
Income from operations 262 1,032 1,756
Other expense, net:
Interest expense (10) (22) (42)
Other income (expense), net 2 (2) (19)
Income before provision for income taxes 254 1,008 1,695
Provision for income taxes 25 402 695
Net income $229 $606 $1,000
Net income attributable to participating
securities 107 234 332
Net income attributable to Class A and
Class B common stockholders $122 $372 $668
Earnings per share attributable to Class
A and Class B common stockholders:
Basic $0.12 $0.34 $0.52
Diluted $0.10 $0.28 $0.46
Pro forma earnings per share attributable
to Class A and Class B common stockholders (unaudited):
Basic $0.49
Diluted $0.43
Share-based compensation expense included
in costs and expenses:
Cost of revenue $-- $-- $9
Marketing and sales 2 2 43
Research and development 6 9 114
General and administrative 19 9 51
Total share-based compensation
expense $27 $20 $217
Revenue Growth Has Slowed.
Sales growth appears to have slowed in the first quarter of 2012, with a 45% increase in first
quarter 2012 over the first quarter of 2011. In addition, Facebook's sales revenue dropped 6%
from the fourth quarter 2011 to the first quarter of 2012. 14
An emergent question is, seemingly, are the times of rapid growth for Facebook all but over?
Facebook's user growth rate as tracked by comScore increased by only 5% in the U.S. from April
2011 to April 2012, which is Facebook's lowest growth rate since comScore began tracking the
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data in 2008. The U.S. user growth rate was 24% from 2010-2011 and 89% from 2009-2010. The
growth rate in the time spent by users of Facebook in the U.S. was 16% in 2012, down from a
23% increase in 2011, and a 57% surge in 2010. 15
It looks like the U.S. market for Facebook may be maturing, but there are still growth
opportunities in Latin America and China. Renren is the largest online social network in China
with 154 million users while Facebook has only a very small share of that market. Google pulled
out of China because the Chinese government sought to both censor and monitor internet traffic.
After the Google exit from China, Baidu filled the vacuum and obtained Google's former market
share. It is open to question whether Facebook can crack open the Chinese market considering
the censorship and internet monitoring issues. 16
Based on metrics collected by Socialbakers, a social media and digital analytics company, there
may still be room for revenue growth globally. Socialbakers listed Latin America as the fastest
growing region for Facebook, with Brazil alone growing by 46% in the past six months. 17
Facebook's market penetration by continent is charted in Exhibit 7.
Exhibit 7: Facebook Population and Market Penetration by Continent
Facebook Market
Continent Population Penetration
Europe 234,330,720 28.88%
Asia 229,032,000 5.92%
North America 223,526,440 42.29%
South America 124,169,900 31.31%
Africa 42,176,720 4.63%
Australia and Oceania 13,788,300 39.78%
867,024,080 \
Potential Revenue Growth from Mobile Devices.
Facebook is looking to expand advertising revenues in the mobile device market with mobile ads
for smartphone apps. Facebook's Connect feature allows people log into millions of websites and
apps. By tracking the apps people use through the Connect feature, ads can be targeted based
on the data collected. Then Facebook would charge advertisers when an app is installed on a
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smartphone. Similarly, Apple targets ads based on which apps a user downloads from iTunes
and the Apple App Store. However, neither Google nor Apple track data on what smartphone
users do with their apps. 18
Facebook has started putting its ads on other websites including Zynga. Zynga is a provider of
social gaming apps that work on Zynga.com, on Facebook, and on mobile platforms including
Google Android and Apple iOS devices. Zynga games include Words With Friends, Zynga Poker,
Cityville, Farmville, and about a dozen others. Zynga's games had over 292 million users as of
April 2012. Game players will be required to use their Facebook accounts to access Zynga.com.
Through Zynga, Facebook is going to attempt to expand revenue in the mobile market. Facebook
and Zynga currently have a revenue-sharing agreement where Facebook keeps approximately
30% of the ad revenue generated on Zynga, which accounts for approximately 12% of
Facebook's revenue. 19
Valuation of Common Stock by Facebook
According to the SEC Registration Statement Form S-1, Facebook considered numerous
objective and subjective factors to determine their best estimate of the fair value of their Class B
common stock, including but not limited to, the following factors: 20
Recent private stock sale transactions.
Historical financial results and estimated trends, and prospects for Facebook's future
financial performance.
Performance and market position relative to competitors and similar publicly traded
companies.
The economic and competitive environment, including the industry in which Facebook
operates.
Independent third-part valuations completed as of the end of each quarter.
Facebook conducted valuations of their Class B common stock as of the end of each quarter. The
valuations took into account the factors described above and used a combination of financial and
market-based methodologies to determine business enterprise value (BEV), including the
following approaches:
12
Discounted cash flow method (DCFM). DCFM involves estimating the future cash flows
of a business for a certain discrete period and discounting such cash flows to present value.
If the cash flows are expected to continue beyond the discrete time period, then a terminal
value of the business is estimated and discounted to present value. The discount rate
reflects the risks inherent in the cash flows and the market rates of return available from
alternative investments of similar type and quality as of the valuation date.
Guideline public company method (GPCM). GPCM assumes that businesses operating in
the same industry will share similar characteristics and that the subject company's value will
correlate to those characteristics. Therefore, a comparison of the subject business to similar
businesses whose financial information and public market value are available may provide a
reasonable basis to estimate the subject business's value. The GPCM provides an estimate
of value using multiples derived from the stock prices of publicly traded companies. In
selecting guideline public companies for this analysis, Facebook focused primarily on
quantitative considerations, such as financial performance and other quantifiable data, as
well as qualitative considerations, such as industry and economic drivers.
Market transaction method (MTM). MTM considers transactions in the equity securities of
the business being valued. During 2011, there were private stock sale transactions in
Facebook common stock. These transactions are considered if they occur with or among
willing and unrelated parties. For the MTM estimates, Facebook evaluated all transactions in
the quarter with particular focus on transactions that were closer in proximity to the valuation
date. Facebook choose the weighting for the MTM each quarter based on factors such as
the volume of transactions in each period, the timing of these transactions, and whether the
transactions involved investors with access to Facebook's financial information.
Because these were the methods used to value Class B, the present authors considered them in
our valuations as well. Exhibit 8 is a summary of our calculated share prices. The prices
calculated using these methods are all well below the Facebook IPO price, ranging from a low of
$9.59 to a high of $16.48. The summary is followed by Exhibits 9-14 which provide calculation
detail for each method used. Exhibits 17-20 provide additional valuation approaches including
using average multiples from a smaller group of comparable companies, and DCF calculations
using EBITD A as a proxy for cash flow under several assumptions.
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Exhibit 8 Summary of Calculated Stock Prices
Summary Price Assumptions
Earnings Valuation 16.48$ 30% AG, DR 11%
Cash Flow Valuation 12.68$ 30% AG, DR 11%
Earnings Time Vary Valuation 18.99$ EG 50% yr.1,30% therafter, DR 15% yr1, 11% therafter
Cash Flow Time Vary Valuation 14.61$ EG 50% yr.1,30% therafter, DR 15% yr1, 11% therafter
GCM P/E 14.16$ Price/Earning Guidline Company Method
Transaction Method Pratt Stats P/S 9.59$ Direct Market Data Method, Price to Sales Ratio
Method 1: Earnings Method DCF
Exhibit 9 illustrates the earnings method DCF, a traditional discounted cash flow method using
earnings per share. Assumptions are a 30% annual growth rate and a discount rate of 11%.
Exhibit 9. Method 1: Earnings Method DCFYear 1 Year 2 Year 3 Year 4 Year 5 Terminal
EPS Growth 30% 0.52$ 0.68$ 0.88$ 1.14$ 1.49$ 1.93$ 2.51$
PV DR 11% 1.11 1.23 1.37 1.52 1.69 22.82
PV-Stock Price 16.48$ 0.61$ 0.71$ 0.84$ 0.98$ 1.15$ 12.20$
Method 2: Cash Flow Method DCF
Exhibit 10 illustrates the cash flow method DCF, a traditional discounted cash flow method using
cash flow per share. Assumptions are a 30% annual growth rate and a discount rate of 11%.
Exhibit 10. Method 2: Cash Flow Method DCF
Year 1 Year 2 Year 3 Year 4 Year 5 Terminal
CF Growth 30% 0.40$ 0.52$ 0.68$ 0.88$ 1.14$ 1.49$ 1.93$
PV 1.11 1.23 1.37 1.52 1.69 17.55
PV-Stock Price 12.68$ 0.47$ 0.55$ 0.64$ 0.75$ 0.88$ 9.38$
Methods 3 and 4: Time Vary Cessation Earnings and
Cash Flow
Exhibit 11 and 12 consider the methodology of Saha & Malkiel. 21The assumptions vary for the
period, with a growth rate of 50% for year 1, 30% thereafter. Assumptions are a discount rate of
15% in year 1 and 11% thereafter. This method adjusts the discount rates based on the risk of
cessation of the business.
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Exhibit 11. Method 3: Time Vary Cessation Earnings
Year 1 Year 2 Year 3 Year 4 Year 5 Terminal
Earnings Growth 50%,30% 0.52$ 0.78$ 1.01$ 1.32$ 1.71$ 2.23$ 2.90$
PV 1.15 1.23 1.37 1.52 1.69 26.33
PV-Stock Price 18.99$ 0.68$ 0.82$ 0.96$ 1.13$ 1.32$ 14.08$
Exhibit 12. Method 4: Time Vary Cessation Cash Flow
Year 1 Year 2 Year 3 Year 4 Year 5 Terminal
CF Growth 50%,30% 0.40$ 0.60$ 0.78$ 1.01$ 1.32$ 1.71$ 2.23$
PV 1.15 1.23 1.37 1.52 1.69 20.25
PV-Stock Price 14.61$ 0.52$ 0.63$ 0.74$ 0.87$ 1.02$ 10.83$
Method 5: GPCM based on Average P/E Ratios for Listed
Peers
In Exhibit 13 there is an illustration of the guideline public company method based on average
P/E ratios for the peer companies, such as Apple and Google, that are listed in the prospectus.
The calculated share value for Facebook is $14.16 per share.
Exhibit 13. Method 5: GCM Based on Average P/E Ratios for Peers
Listed in the Prospectus
Peers P/E
Accenture 15.22
Adobe Systems 20.37
Apple 14.12
Cisco Systems 12.36
eBay 16.72
Google 17.23
Intuit 24.08
Microsoft 11.18
NetApp 19.03
Oracle 14.26
Yahoo! 17.65
AOL 95.20
Electronic Arts 53.61
VMware 50.15
Total 381.18
Avg. P/E 27.23
EPS 0.52
Stock Price 14.16$
15
Method 6: Market Transaction Method
Using the direct market data method and the Pratt's Stats database, we selected 29 transactions
from SIC Code 7375. We then applied an average Market Value of Invested Capital/Sales
(MVIC/Sales) multiple. The average MVIC/Sales was 7.082758621. As displayed in Exhibit 14,
the resulting share price is $9.59 per share.
Exhibit 14. Method 6: Market Transaction Method Pratt's Stats
Market Transaction Method Pratt's Stats
Average MVIC/Sales 7.082758621
Sales $3,711,000,000
Facebook MVIC 26,284,117,241$
Shares Outstanding 2,740,000,000 Price Per Share 9.59$
Comparing Facebook to LinkedIn, Google, Microsoft, and
Apple
For additional analysis, we also examined key statistics of LinkedIn, Google, Microsoft, and Apple
as compared to Facebook. Exhibit 15 presents key company statistics as compiled by Yahoo
Finance.
Exhibit 15: Key Statistics for Facebook, LinkedIn, Google, Mircosoft, Apple
Company Facebook LinkedIn Google Microsoft Apple
Share price July 1, 2012 30.77 107.63 580.47 30.56 592.52
Market Cap (intraday): 65.79B 11.12B 189.24B 256.73B 554.04B
Enterprise Value 63.29B 10.36B 149.20B 211.98B 517.54B
Trailing P/E (ttm, intraday): 76.74 737.19 17.59 11.19 14.44
Price/Sales (ttm): 16.46 17.80 4.73 3.52 3.84
Profit Margin (ttm): 24.07% 2.40% 27.09 31.97% 27.13
Revenue (ttm): 4.04B 616.71M 39.98B 73.03B 142.36B
Revenue Per Share 1.79 6.72 123.49 8.69 153.11
Diluted EPS (ttm): 0.40 0.15 33.00 2.73 41.04
Balance Sheet Total Cash 3.91B 620.81M 47.62B 58.16B 28.54B
Operating Cash Flow 1.64B 170.08M 15.09B 29.89B 53.07B
Operating Cash Flow Per Share 0.76 1.52 45.69 56.16
Price/Operating Cash Flow 40.11585 70.8092105 12.7045305 10.55057
Source: Yahoo Finance Key Statistics July 1, 2012
*Source: Yahoo Finance Key Statistics 7/1/2012
16
Using the above comparative data, we can calculate average multiples for price to earnings, price
to sales, and price to operating cash flow. Using these average multiples, the calculated share
price is $33.66 per share as illustrated in Exhibit 16. While we now have a calculation more in line
with the Facebook IPO price, it is important to note that the LinkedIn multiples are much higher
than those of mature companies like Google, Apple, and Microsoft and push the average
multiples significantly higher.
Average Facebook Price/Share
Multiples Facebook $B Ent Value $B 2.74B Sh
P/E 195.1025 $1 $195.10 $71.21
P/Sales 7.47 $4.04 $30.19 $11.02
P/Operating CF 31.3547703 $1.64 $51.42 $18.77
Price Per Share Average $33.66
Exhibit 16: Average Multiples - LinkedIn, Google, Apple and Mcrosoft Applied to Facebook
DCFM Using EBITDA as a Proxy for Cash Flow
Another valuation approach would be to use EBIDTA as a proxy for cash flow and then apply the
discounted cash flow approach to the data. Facebook's EBIDTA has grown over the past three
years as illustrated in Exhibit 17.
Exhibit 17: Facebook EBIDTA 2009 Actual 2010 Actual 2011 Actual
Net Income 229,000,000 606,000,000 1,000,000,000
Depreciation and Amortization 78,000,000 139,000,000 323,000,000
Interest Expense 10,000,000 22,000,000 42,000,000
Taxes 25,000,000 402,000,000 695,000,000
EBIDTA 342,000,000 1,169,000,000 2,060,000,000
Exhibits 18-20 demonstrate that stock valuations using the DCFM method with EBITD A as a
proxy for cash flow vary widely, depending on the projected growth for Facebook. Clearly,
investors and analysts are betting on very large compound growth numbers for Facebook to
justify the high stock price valuations. If we assume a 30% annual growth rate for the next five
years with 11% per year thereafter, the stock price is $16.71. If we assume a 50% growth rate for
the next five years with 11% thereafter, the stock price increases to $27.93. We backed into a
63% growth rate over the next five years to arrive at a stock price of approximately $38 per share
(the IPO price).
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Exhibit 18: USING EBITDA AS A PROXY FOR CASH FLOW
2011 Actual 2012 2013 2014 2015 Thereafter
Net Income 1,000,000,000 1,300,000,000 1,690,000,000 2,197,000,000 2,856,100,000
Depreciation and Amortization 323,000,000 419,900,000 545,870,000 709,631,000 922,520,300
Interest Expense 42,000,000 54,600,000 70,980,000 92,274,000 119,956,200
Taxes 695,000,000 903,500,000 1,174,550,000 1,526,915,000 1,984,989,500
- - - - -
EBIDTA 2,060,000,000 2,678,000,000 3,481,400,000 4,525,820,000 5,883,566,000 6,065,956,546
Capitalization Rate 11.00%
Terminal Value 55,145,059,509
Discount Rate 11% 0.900900 0.811620 0.731190 0.658730 0.593450 0.593450
Net Present Value 1,855,854,000$ 2,173,518,360$ 2,545,564,866$ 2,981,293,409$ 3,491,602,243$ 32,725,835,566$
Indicated Value 45,773,668,443$
Shares Outstanding 2,740,000,000
Price per Share 16.71$
Discounted Earnings (Cash Flow) Method GR 30%, Discount Rate 11%
Exhibit 19: USING EBITDA AS A PROXY FOR CASH FLOW
2011 Actual 2012 2013 2014 2015 Thereafter
Net Income 1,000,000,000 1,500,000,000 2,250,000,000 3,375,000,000 5,062,500,000
Depreciation and Amortization 323,000,000 484,500,000 726,750,000 1,090,125,000 1,635,187,500
Interest Expense 42,000,000 63,000,000 94,500,000 141,750,000 212,625,000
Taxes 695,000,000 1,042,500,000 1,563,750,000 2,345,625,000 3,518,437,500
- - - - -
EBIDTA 2,060,000,000 3,090,000,000 4,635,000,000 6,952,500,000 10,428,750,000 10,752,041,250
Capitalization Rate 11.00%
Terminal Value 97,745,829,545
Discount Rate 11% 0.900900 0.811620 0.731190 0.658730 0.593450 0.593450
Net Present Value 1,855,854,000$ 2,507,905,800$ 3,389,065,650$ 4,579,820,325$ 6,188,941,688$ 58,007,262,544$
Indicated Value 76,528,850,006$
Shares Outstanding 2,740,000,000
Price per Share 27.93$
Discounted Earnings (Cash Flow) Method GR 50%, Discount Rate 11%
Exhibit 20: USING EBITDA AS A PROXY FOR CASH FLOW
2011 Actual 2012 2013 2014 2015 Thereafter
Net Income 1,000,000,000 1,630,000,000 2,656,900,000 4,330,747,000 7,059,117,610
Depreciation and Amortization 323,000,000 526,490,000 858,178,700 1,398,831,281 2,280,094,988
Interest Expense 42,000,000 68,460,000 111,589,800 181,891,374 296,482,940
Taxes 695,000,000 1,132,850,000 1,846,545,500 3,009,869,165 4,906,086,739
- - - - -
EBIDTA 2,060,000,000 3,357,800,000 5,473,214,000 8,921,338,820 14,541,782,277 14,992,577,527
Capitalization Rate 11.00%
Terminal Value 136,296,159,338
Discount Rate 11% 0.900900 0.811620 0.731190 0.658730 0.593450 0.593450
Net Present Value 1,855,854,000$ 2,725,257,636$ 4,001,959,345$ 5,876,753,521$ 8,629,820,692$ 80,884,955,759$
Equity Value Before Discounts 103,974,600,953$
Shares Outstanding 2,740,000,000
Price per Share 37.95$
Note: A growth rate of 63% gets us to the IPO price of approximately $38 per share
Discounted Earnings (Cash Flow) Method GR 63%, Discount Rate 11%
18
Conclusion
From the fundamental analysis view it appears that Facebook's initial public offering price
suffered from high expectations rather a tenable valuation. As we have illustrated in our
calculations Facebook's price is very sensitive to the underlying assumptions that drive value.
Some of these assumptions can certainly overshoot reality, such as a 63% growth rate for five
years. In the end, this exercise imparts to wary investors and analysts a call to drill down in the
abundance of information that accompanies an initial public offer. The registration statement
Form S-1 is replete with relevant details.
Reference List
1 Puzzanghera, “Facebook, Morgan Stanley Face Class-Action Suit Over IPO,” Los Angeles
Times, 5/23/2012, http://articles.latimes.com/2012/may/23/business/la-fi-mo-facebook-suit-
20120523.
2 Id.
3 Harper, “Goldman to Cash Out $1 Billion of Facebook Holding in IPO,” Bloomberg.com,
5/17/2012, http://www.bloomberg.com/news/2012-05-17/goldman-to-cash-out-1-billion-of-
facebook-holding-in-ipo.html.
4 Facebook SEC Form S-1 Registration Statement, pp. 20-21, 2/1/2012,
http://sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm.
5 Vardi, “The Rush for the Exits Doomed Facebook's Stock,” Forbes, 5/23/2012,
http://www.forbes.com/sites/nathanvardi/2012/05/23/the-rush-for-the-exits-doomed-facebooks-
stock/.
6 Wang, and Chaykowski, “Facebook Analysts See Shares Staying Less Than $38 IPO Price,”
Bloomberg.com, 6/27/12, http://www.bloomberg.com/news/2012-06-27/facebook-analysts-see-
shares-climbing-10-cents-above-ipo-price.html.
7 NASDAQ, “Facebook Stock Research-Analyst Summary,” 7/13/12,
http://www.nasdaq.com/symbol/fb/analyst-research.
8 Id.
9 See Scaggs, Demos, and Benoit, “Analysts Hit the Tepid Button on Facebook,” Wall St. J.,
6/28/12, p. C1.
19
10 See Facebook SEC Form S-1 Registration Statement, note 4, supra at pp. 5-6.
11 See Facebook SEC Form S-1 Registration Statement, note 4, supra at p. 12.
12 See Facebook SEC Form S-1 Registration Statement, note 4, supra at p. 1.
13 See Facebook SEC Form S-1 Registration Statement, note 4, supra at p. F-4.
14 LaMonica, “5 reasons to not 'like' Facebook's IPO.” CNN Money, 5/4/2012,
http://money.cnn.com/2012/05/04/markets/thebuzz/index.htm.
15 See Raice, “Days of Wild User Growth Appear Over at Facebook,” Wall Str. J., 6/11/2012
p.B1.
16 Qineqt, “Buy Renren: The Facebook Of China,” Seeking Alpha, 7/4/2012,
http://seekingalpha.com/article/701751-buy-renren-the-facebook-of-china.
17 Socialbakers, “Facebook Statistics 2012: Top-Growing Countries,”
http://www.socialbakers.com/blog/684-facebook-statistics-2012-top-growing-countries/.
18 Raice, “Facebook to Target Ads Based on App Usage,” Wall St. J., 7/6/2012, p. B3.
19 Ahanotu, “Untangling the Facebook-Zynga Embrace: The Basis for a Relative Valuation for
Zynga,” Seeking Alpha, 5/24/ 2012, http://seekingalpha.com/article/520601-untangling-the-
facebook-zynga-embrace-the-basis-for-a-relative-valuation-for-zynga.
20 See Facebook SEC Form S-1 Registration Statement, note 4, supra at pp. 63-64.
21 See Saha and Malkiel, “Valuation of Cash Flows with Time-Varying Cessation Risk,” 7 J.
Business Valuation and Economic Loss Analysis. Issue 1, Article 3 (2012).
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