Facebook IPO – Is the company really worth $100 billion?

As mentioned in a previous article, IPOs in 2011 have been either hit or miss, with most only performing on their first day and crumbling thereafter. The Facebook IPO should raise some red flags to most investors as the 10 percent stake up for grabs is worth USD 10 billion. The main question is: Is Facebook actually worth USD 100 billion?  A quick look at the company’s top and bottom line will hopefully answer this question.

According to eMarketer, Facebook’s advertising revenue has increased from USD 2 billion in 2010, to over USD 4 billion in 2011 with 89 percent of those revenues coming from pure advertising and the rest earned through Facebook Credits. And as we can see from Table 1 Facebook Credits are growing at a tremendous pace, much faster than the traditional advertising revenues that other competitors like Google and Yahoo earn.

As of the end of 2011, and considering the IPO and the company value of approximately USD 10 billion and 100 billion respectively, currently Facebook has a P/E of 100 which seems extremely steep. But if Facebook can grow its profits at the past rate of +100 percent for the next three years, then it will be sitting at a FY3 PE valuation (2014) of around 12, which does not seem so extreme anymore. Of course the growth is questionable but it does make you think cleverly about the potential of the IPO and its valuation.

If we compare another technology company, albeit with a different business model, Amazon which has a FY1 PE of approximately 100, we can compare from a bottom perspective the merits of both of these highly valued companies. In table 2, we see the Amazon.com revenue and profit numbers and while the company has had tremendous growth, it has a low profit margin and its PEG ratio is around 3.4 (compared to a possible PEG ratio of 1.5 for Facebook), highlighting the high price that investors are willing to pay for the company's growth. And if we do a similar back of the envelope calculation for Amazon's historical growth and assume that it will continue until 2014, than the company's FY3 PE will still be at around 40 vs Facebook's 12.

If investors doubt the growth of online advertising and the reach of Facebook, tables 3 and 4 show the strength of the advertising revenues of Facebook. Facebook has had 12 percent of all the online advertising revenue in the US in 2010. And this significant market share is expected to grow close to 20 percent in 2012. This is pretty significant considering that that US online advertising revenues are expected to grow to USD 15 billion by 2012.

Investors have been punished with IPOs that have resulted in good one day results but turned out to be terrible trading ideas past the initial  euphoria. Although the Facebook IPO is expected to be priced at a high level, and as always if the growth is realised, then Facebook might not be that shabby of a stock to buy after all.