What is Facebook really worth? Not as much as some people think.

What’s Facebook worth? A search on the internet on “Facebook Value” produces result after result of USD 100bn, as if it is a given. If it is an orchestrated campaign, it seems to be working.

Using my trusty pocket calculator, I spent a couple of hours this weekend trying to assess the value of Facebook in a transparent way and see if I was able to reach some meaningful valuation level of my own.

Of course, there are many moving parts in this exercise and the sample space is wide, leaving massive room for error.  But according to my most generous allowances, Facebook could increase revenue from USD 3.7bn in 2011 to USD 11bn in 2014. A total growth of 200 pct. Net income rises even more from USD 668m to USD 2.2bn a growth of 235 pct.

Where does this lead us in terms of market value? I would probably set a maximum P/E in 2014 of 25 times earnings, which leaves a value today of 25 X USD 2.2bn = USD 55bn, which translates to a 2011 P/E of 82 times and P/E 2012E of 60 times.

Mark Zuckerberg’s big problem
Yesterday, Sverrir Sverrisson highlighted some of the restrictions of the final destination of the numbers of users. Maximum in the coming years is probably in the range of 1.4bn users and in this theme I add 100m users per year as we are approaching the maximum. This is actually 1½ times the users in Europe right now added at the top – so I have not put the brakes on! This translates into a growth trajectory seen in chart 1. This is not happy reading for Mark.

What are we calculating?
Revenue:  Facebook will pursue an aggressive strategy to get new income streams on-board which are not advertising. More users are using mobile which today does not provide revenue. Facebook needs to find revenue in the “digital” arena via a model more like Apple’s App store or iTunes, where they are able to claw back a percentage of the sales.

The revenue projection begins with assumptions about the ARPU (average earnings per user). This has risen from USD 3.1 (2009) to 5.1 (2011). The growth the coming years I set to 25 percent a year, which actually brings ARPU to a stunning USD 10 per year. This might be too high, but Mark will aim for it – don’t doubt it.

Number of users is set to rise 100m per year and ends 2014 with 1150m users. The revenue then adds up to just shy of USD 11bn revenue in 2014, see table 1.
 

Net Income: The margin has been 18-19 percent the last two years. One factor which is going to lift the margin is the aim to increase digital sales. I set margins on “digital” to 33 percent which mimics Microsoft margin – probably an ok reference. I set digital to 60% of the overall growth. This lifts the margin to 22.4 percent in 2014 from the 18.8 today.

A drag will come from “user acquisition”. Facebook has been blessed for years as users have entered their social network at a very (!) low cost to Facebook. This is changing!  Facebook increased marketing from 184m to 427m in 2011 which translates to USD 1.8 per new user, up more than 100 percent in just one year!

As we don’t expect it to become easier the coming years as the remaining pool of potential users shrink and competition increases, we increase the necessary marketing to USD 650m. This will lift acquisition cost rapidly over the coming years, see table 1!  A consequence of this extra marketing is a drag on the margin. The above two effects are reflected in table 1, where the margin rises to 20.4 percent in 2014.

Looking at chart 2 where both revenue and net income developments are drawn it is clear that the projection is fairly aggressive, but again Mark Zuckerberg is expected to be exactly that - aggressive.
 

Valuation?
Valuation is not an exact science and this is both the exciting part but also frustrating as it ends up like measuring a meter with a rubber band.
What is a limitation to Facebook’s growth model is population. Facebook has been eminent in getting new users and looking at 845m users is breathtaking. The road ahead is less rosy as Facebook has to fight more the rest. Google owns Orkut which is present in both Brazil and India and Google has cash to fight with. See also theme How large can Facebook become? for more details on the market size.

The business models in social media have changed some of the landscape in advertising. The question is what other revenue streams are coming? Looking at numbers today of ARPU of USD 5.1 and my calculations of USD 10 in 2014 is an increase of 100%. This is somehow huge – as Facebook has to steal advertising from others as the “pool” is more or less given. The growth has therefore to come from users changing their behaviour and/or new products we are not able to understand today. This makes the projections difficult.

In this analysis it is easy to get excited in the moment and just think this will go to the moon. Facebook will continue to thrive – but this is not the same as any stock price or markets cap is valid.

Alternative stock investments
You are able to invest in Google, Microsoft and Apple at very reasonable P/E multiples. Growth has been ticking down and therefore P/E declines. For Apple the growth is still huge, but investors are already taking into account it will decline and you pay only 10.7 times 2012E.

P/E contraction should also happen to Facebook: the P/E cannot just be any number. To mark a level where P/E seems reasonable, I set P/E in 2014 25 times earnings. Investors pay for further development (after 2014!) but know that the growth is more uncertain. This translates to P/E 2011 of 82 times and for 2012E a level of 60 times – high ratios where the future better pans out well.

Conclusion
The above calculations and assumptions translate to a market cap of around USD 55bn. This is more of a guesstimate as there are so many unknowns in the social media space.  But even though there is uncertainty it is difficult to get to a level of USD 100bn which is a number frequently is referred to in media.