Facebook IPO Valuation - Part 2
By Alexander Chepakovich, CFA 2012-02-08Let's take a deeper look into Facebook's business, and start with the all-important for Internet companies parameter – revenue. The company basically has two sources of revenue: 1) advertising, and 2) fees associated with its payments infrastructure that enables users to purchase virtual and digital goods from its platform developers.
The advertising revenue is generated by displaying ads and is based on the number of times ads are shown (impressions) or the number of clicks made by users.
The second source of revenue stems from Facebook being a platform on which outside developers can offer their "virtual and digital goods". In theory such fees can come from different type of applications, business development transactions, mobile providers and so forth, but in reality now they come almost exclusively from games (read "Zynga"). The company receives a negotiated fee from the developers every time users purchase from them.
Now let's take a look at the actual numbers. And they are really impressive. Facebook's revenue increased from $153 million in 2007 to $3,711 million in 2011, or 24-fold, in just four years! This is fantastic, but to valuate the company (and for value investors this means calculating its intrinsic value), we need to know (or estimate) what revenues will be in the future.
Clearly, revenue growth rate will decline – as it has been doing for the last two years: from 186% in 2009 to 154% in 2010 and to 88% in 2011. An indication of what can be expected in 2012 can be found in the quarterly data: in the last quarter of 2011 revenue has increased by only 55% compared to the last quarter of 2010. At first glance, this is not a representative number because in al three previous quarters revenue grew by slightly more than 100% compared to the corresponding quarters a year earlier.
However, a deeper look into the matter reveals quite a troubling picture: the 55% y-o-y quarterly increase in revenue is attributed primarily to a 44% increase in advertising revenue. The advertising revenue, in its turn, grew due to a meagre 16% increase in the number of ads delivered and a whopping 24% increase in the average price per ad delivered. In the registration statement the company explains that the increase in average price per ad was driven primarily by "changes that contributed to higher user interaction with the ads by increasing their relative prominence on certain pages" (in plain English – by putting ads in users' faces) and "the higher reserve price for ads" (which means just a plain price hike).
What does mean? That means that despite its desperate attempts (how else to call a move to assign ads a more prominent place at the website) Facebook could not prevent a sharp drop in the revenue growth rate in the last reported quarter. This also means that the period of super high growth is over and that, going forward, revenue growth rates are likely to be well below 50% (I think in the vicinity of 30% for 2012).
Moreover, it means right now (before 1q2012 results are released) is the best chance for Facebook to do an IPO. It also means that company's officers, managers, employees (they know what is happening better than any outsider) and people "in the know" (those venture capitalists and early investors who are close to the company's management) will dump their stock, monetize their stock options and restricted stock units as soon as possible after the IPO. We all know the consequences of this: investors who would buy at the IPO will be left holding the bag.
More on the Facebook IPO valuation is still to follow…