What Facebook is really worth?
By Alexander Chepakovich, CFA 2011-10-12What is the true value of Facebook? Is it $50 billion – the valuation the social network site got at the very end of last year through financing from Goldman Sachs and a Russian firm Digital Sky Technologies, or $78 billion – implied from contracts/trades done on SharesPost, or $100 – the valuation the company purportedly wants to get at an IPO.
In my opinion, all of these numbers are way too high. Let's do a quick back-of-the-envelope calculation – I am afraid we cannot do anything better as Facebook does not disclose any financial nor operational data. We only know that Facebook has around 500 million active users and that around half of them visit the site at least once a day. Well, that's enough for us to get started.
Apparently, all of Facebook's revenues come from online advertising. Therefore, to come up with a valuation of the company, we need to estimate these revenues in the future. To do it, first, we need to make some assumptions. Let's assume that the site will grow to the maximum of 1 billion users (here I would count users primarily in developed countries, where advertisers would be willing to pay reasonably high advertising rates). Further, let's assume that half of these users will visit the site every day with each looking through 10 pages (ads are displayed at each page of Facebook). This would give us 1,825 billion page impressions per year.
So, what is the "monetization rate" for these page impressions? This is not public information. However, knowing going rates in the online advertising industry, it is not unreasonable to assume that the click-through rate (the number of clicks on an ad divided by the number of times the ad is displayed) is 0.2% and the CPM (the cost per thousand of impressions paid by advertisers) is a generous $3 (which translates into $1.5 per click). This would yield Facebook's future annual revenue to be about $5.5 billion (by the way, some estimate the company's 2011 advertising revenue will be around $4 billion).
To get to the net income, we need to subtract costs from revenues. Assuming (minimalistically) that the costs will be $500 mullion per year, we get the net income of around $5 billion per year.
Now, using the P/E ration of 10 (this is a rule-of-thumb number for a mature company, which also implies a 10% yearly return on the investment), we finally come to Facebook's valuation: $50 billion. This is exactly one half of the valuation the company wants to get at the IPO. However, I would not pay even this price for Facebook. My price tag would be $25 billion. Why? For one, the valuation number I came up with above is, in my opinion, the absolute maximum valuation the company can receive today (i.e. based on the information about the market we have now) – due to very favourable assumptions.
Facebook is a great social networking site. The company is innovative and dynamic. It is charging full speed ahead despite competition from the likes of Google. Some stick to it incredibly high valuation numbers. Don't be fooled by all this hype. The company has its intrinsic value, and it is in the range of $20 to $30 billion. Anyone paying more that this will be sorry, unless, of course, he will find a bigger fool to sell to. There is one important caveat to this assessment, though: with technology companies no one really knows in what they eventually will evolve into.