Facebook’s $100 Billion Question

Wall Street Journal

How To Value History’s Biggest Tech IPO? The Answer Will Depend on Growth And Advertisers

What is Facebook worth?

As investors dug into the company’s freshly released financials Wednesday, analysts and investors began circulating a range of values—from as little as $50 billion to as much as $125 billion—for the social-networking website. The company views itself through a relatively conservative lens, pegging its value for employee stock grants at $29.73 per share. Pictured, a meeting area at Facebook’s corporate headquarters in Menlo Park, Calif.

It will be months before the market sets a final price, but already the valuation question has become a tug of war over two essential questions: Just how fast can the company continue to grow? And can it extract value from advertising in the way it plans?

The company views itself through a relatively conservative lens, pegging its value for employee stock grants at $29.73 per share, giving it a total valuation of $74 billion based on the company’s share count of 2.5 billion.

The calculation was performed in a period when the stock market had just suffered a downturn and some Internet stocks were struggling.

How exactly does Facebook’s ad business work? We still don’t know, Peter Kafka reports on digits. Photo: Getty Images.

Since then, Facebook shares have rebounded a bit in private marketplaces to trade at $32 to $33 a share, according to securities traders, which would imply a valuation of about $81 billion.

That is around the low end of an expected range for the company’s offering, according to people familiar with the matter. The high end is $100 billion.

Whether it will hit that mark depends largely on growth. Generally, if a company is growing above 50% a year, it is considered rapid growth.

Facebook’s revenue grew 88% in 2011, and net income grew 65%. Facebook’s growth has already decelerated from 154% from 2009 to 2010, to the 88% it experienced last year. Quarter-to-quarter Facebook profits actually fell during two quarters of 2011 after rising by as much as 92% in 2010.

Francis Gaskins, president of IPOdesktop.com, which analyzes IPOs for investors, says he doesn’t believe Facebook is worth more than $50 billion—50 times its reported profits for 2011 of $1 billion, or more than triple the market’s average price-to-earnings ratio. Google Inc.’s profits are 10 times that of Facebook, but its stock-market value is $190 billion, he notes.

A $100 billion valuation « would have us believe that Facebook is worth 53% of Google, even though Google’s sales and profits are 10 times that of Facebook, » he said.

While other analysts note that Google isn’t growing as fast as it did in the years after its 2004 IPO, Mr. Gaskins says he wasn’t so impressed with Facebook’s recent quarter-by-quarter profit growth.

A Facebook representative declined to comment.

MarketWatch.com’s David Weidner make a stop on Mean Street to tell Evan Newmark despite all the hype surrounding Facebook’s IPO, the company will have very tough go of it on its way to becoming a public company. Photo: AP.

Martin Pyykkonen, an analyst at Denver banking boutique Wedge Partners, is more bullish, saying the value could top $100 billion. He says Facebook could trade at 15 to 18 times next year’s expected earnings before interest, taxes and certain non cash charges, a cash-flow measure known as Ebitda, which he says can comfortably surge from $2.1 billion in 2011 to $4.5 billion in 2013.

By comparison, he says, mature companies trade at eight to 10 times Ebitda. Microsoft Corp. trades at seven times, and Google about ten times, Mr. Pyykkonen says.

While that math only justifies an $81 billion valuation, he says Facebook may be able to unlock faster growth in ad spending and reach $5.5 billion in Ebitda, which could justify a higher multiple of 20 times, implying a $110 billion valuation.

Two obstacles to ad growth, analysts say, are that 80% of Facebook users are overseas, where many ad markets aren’t as well developed. Also, in those markets, analysts say, many users are on mobile devices, which don’t accommodate advertising as easily as home computer screens.

Steven Weinstein, an analyst at ITG Inc., says Facebook’s fourth-quarter ad spending grew 44% from the same quarter of 2010, down from 77% growth in the third quarter and « much slower than what Google reported » when it was at a similar scale. Google’s ad revenue was still growing 86% more than a year after its IPO.

Craig Huber, an independent analyst who follows media and Internet companies at Huber Research Partners in Greenwich, Conn., says that if Facebook’s revenue, which grew 88% to $3.7 billion in 2011, grows by 50% annually in the next two years, it will hit $8.3 billion in 2013.

He estimates that would give Facebook an Ebitda in 2013 of $4.2 billion, an estimate slightly below Mr. Pyykkonen’s.

Mr. Huber notes that LinkedIn Corp., a smaller social network aimed at business connections, trades at 30 times his estimate of its 2013 cash flow. Once Facebook is public, he says, investors could bid the stock up to around 30 times its projected 2013 cash flow level, or $125 billion.

« In other words, » he wrote in a note to clients Wednesday, « getting to a valuation over $100 billion should not be hard. » given, he said, Facebook’s bright outlook and investors’ appetite to own the stock.

Michael Pachter, who follows digital media and videogames at Wedbush Securities in Los Angeles, says a $100 billion valuation assumes Facebook can get to a $10 billion operating profit « someday in the reasonable future. » He says Facebook, whose operating profit for 2011 was just $1.7 billion, can reach that level by drawing in more ad dollars, partly by using information about Facebook users to target promotional offers.


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