Facebook Valuation: Some Context Behind the Numbers
Over the past week there have been numerous articles, blog posts, news reports and conversations about Facebook being worth $50 billion. Some say it is too high while other say it could be a bargain. The one thing that is common is that there is not a lot of information available but there is a lot of speculation. However, with the little bit that is known the valuation could be put in a better context.
It is estimated that Facebook’s net income for 2010 was up to $500 million (extrapolated from reports of their first 9 months of $355 million) on $2 billion revenue. That would make Facebook’s P/E ratio 100. This is significantly higher than other public internet companies like Google (25) and Yahoo (22). If it were treated like a fixed income security it would yield 1%. 3-year Treasury Bonds (my proxy for the risk free rate) are yielding 0.98% (1/7/2011) so Facebook would not provide a great return for the additional risk of an early stage company with little financial disclosure.
From a fundamental perspective it makes sense why fundamental investors would want to unfriend Facebook. But is this really the right way to value a growing internet company that has unprecedented reach?
What Investors are Really Buying???
Growth… but what does that mean? With the deep level of user engagement and potential profit these users represent there are other metrics that could be used to value Facebook. Long-term value of users would give a better perspective of how much Facebook should be worth. At between 500 – 600 million users, the latest valuation would represent $83 – $100 per user. A key question is can the company earn at least this much for each user over their lifetime with the service. In 2010 earnings on average was $1/user on revenue of $4/user. It is well known that making money is not a priority for Facebook at this time so it will be interesting to see how quickly they can grow earnings per user, because the users won’t be around for 100 years to recoup the money.
There is also the question of how many more users are there who could join Facebook in the future. Current stats show that 2 billion people are on the internet so there is still a lot of upside for growing the number of users. User count could theoretically double which is crazy to think of. I would guess that the incremental cost of adding users would be cheaper than the first few hundred million as they have economies of scale.
Overall there is room for Facebook to grow revenue, earnings and users but at the current valuation they will have to execute really well to justify the valuation.
How Does Goldman Sachs Fit Into This???
Goldman Sachs’ (GS) investment provides credibility to the $50 billion valuation but there are also a lot of benefits for Goldman as well. Direct ownership of Facebook stock gives GS the upside of Facebook stock when it goes public and the ability to earn fees from others who want the stock so badly they will pay fees to invest in the Facebook special purpose investment vehicle. Assuming Facebook matures to a similar market cap as Google, GS shares could increase 3-4x in the future.
Yet the real benefit are the intangibles. Similar to the British Petroleum deal in the 1990s, GS proves that it can move a large block of shares for an in demand company. It also gives it favorable access to a company that is likely to become increasingly important in the technology field. Secondary offerings, M&A and advisory work all carry future fees. Plus the additional access in the social media space will improve their institutional knowledge making it easier to make money from proprietary investing, research and seeking new business.
No doubt about it, Facebook’s user base and valuation are growing quickly. Ideally if you are “investing” it is better to get more details so you can do some due diligence. However, if you have a few million to “speculate” think about why you are buying the stock, look at the information you have in a greater context and then make your decision. Value is different for everyone so you have to make your own call on value. There are several more techniques, that could have been used for this analysis as well.
Talk to you soon,
Orville | Twitter: @orville_m