What’s Facebook really worth?

March 22, 2012

By Richard Beales
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Facebook’s 31 underwriting banks are mobilizing for the company’s initial public offering. In such a hyped IPO, any kind of valuation is possible. But a comparison with the history of the social network’s closest thing to a rival, Google, suggests that even $75 billion – at the low end of the talk to date – would be a stretch. A new Breakingviews calculator shows why, and allows bulls and bears alike to tweak the inputs.

Google’s revenue of $3.2 billion in 2004 was not far off Facebook’s $3.7 billion in 2011. One way to clarify the crystal ball is to assume the social network grows on the same trajectory as the search engine did seven years earlier. Then it’s consistent to assume EBIT margins settle at something like Google’s average 33 percent level.

Add a 30 percent tax rate and modest outlays for investments, and out pops an annual free cash flow figure to plug into a discounted cash flow model based on one created by Anant Sundaram at Dartmouth’s Tuck School of Business. A 15 percent discount rate seems rational for a business in the fast-changing Internet world, resetting lower – along with revenue growth – after 2021.

Run those numbers, and Facebook founder Mark Zuckerberg is presiding over a company worth $75 billion, or about $30 per pre-IPO share. But the pricing of run-of-the-mill floats is supposed to leave something – say 15 percent – on the table for incoming shareholders. That would knock the figure down below $65 billion. And with nearly two-thirds of the value stemming from cash flows more than 10 years hence, Facebook is a risky bet.

For likers of Facebook, however, it’s easy to dial things up. Just trimming 2.5 percentage points off the discount rate, say, adds $15 billion to the valuation. But the valuation is also sensitive on the way down. Shaving just 5 percentage points off near-term revenue growth and margin assumptions knock it down by $10 billion.

Facebook shares may prove scarce as would-be owners, potentially including many of its 845 million users, clamor for a piece of the IPO action. A staid DCF analysis could easily be drowned out. But it does at least show how bold the assumptions must be to justify whatever price the underwriters end up persuading investors to pay to cement their friendship.

Comments

So, let’s not quibble since we’re guessing at future cash flows anyway, and let’s start with the $75 billion valuation.

Let’s then:

- Subtract, say, $1 trillion for the lost productivity caused by Americans wasting away their lives “Friending” people they really don’t care about anyway
+ And add back, say, $100 for the extra productivity from us because our deadbeat brothers-in-law now stay at home playing Zynga with “Friends” on-line instead of dropping by for a beer.

There.

We figure Young Zuckerberg and his band of Merry Hackers, the new 20-somethings who have innovated the United States into a fearsome new advertising- and on-line-game based economy, owe America: ($75,000,000,000 – $1,000,000,000,000 + $100 = ) $924,999,999,900.

We’ll take installments. They can send their first $75 billion to the Treasury and work off the rest assembling iGadgets made in the new Apple plant being built by Mike Moore in Flint, Michigan. Since there are exactly 17 employees working in Facebook, this new economy company, the debt works out to about $54 billion per head. We figure it’ll take them, productive as they are, 54,000 years each to make repayment, a little less, perhaps, with some inflation.

Our thanks to Reuters for helping solve this vexing public policy issue.

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