valuing facebook: hype and...

1

Checkpoint Contents

Federal Library

Federal Editorial Materials

WG&L Journals

Valuation Strategies (WG&L)

Valuation Strategies (WG&L)

Preview Issue in Progress

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

https://checkpoint.riag.com/app/find?begParm=y&appVer=9.8&dbName=VLR&linkType=docloc&locId=vlr09201207&ods=VLR&permaId=i48310d930ce46bafe6639e39f39ded1d&permaType=doc&tagName=STORY&endParm=y

https://checkpoint.riag.com/app/find?begParm=y&appVer=9.8&dbName=VLR&linkType=docloc&locId=vlr09201207&ods=VLR&permaId=i48310d930ce46bafe6639e39f39ded1d&permaType=doc&tagName=STORY&endParm=y

2

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

4

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

5

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.”

6

“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

7

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.

8

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

9

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

10

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

11

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.

13

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.

14

Exhibit 11. Method 3: Time Vary Cessation Earnings


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


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).

17

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%



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


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



Discount Rate 11% 0.900900 0.811620 0.731190 0.658730 0.593450 0.593450


Indicated Value 76,528,850,006$






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


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



Discount Rate 11% 0.900900 0.811620 0.731190 0.658730 0.593450 0.593450


Equity Value Before Discounts 103,974,600,953$



Note: A growth rate of 63% gets us to the IPO price of approximately $38 per share


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).

© 2012 Thomson Reuters/RIA. All rights reserved.

valuing facebook: hype and...

Documents