Thursday, January 8, 2015

Facebook IPO $100 Billion Valuation Is Not So Overpriced

When it comes to the largest social networking site, everybody things of one name,Facebook, along with the famous young founder, Mark Zuckerberg. Facebook, from the Harvard dormitory room of eight years ago, is taking its first step to become a publicly traded company, the largest Internet initial public offering ever, with the target valuation of $75 billion to $100 billion – surpassing Google's (GOOG) IPO in 2004 or Netscape's in 1995.

Mark Zuckerberg, has detailed the company's mission and vision in his letter. He said that at first, Facebook was created not to be a company; it was built to fulfill the social mission of making the world more open and connected. He wrote: "People sharing more – even if just with their close friends or families – creates a more open culture and leads to a better understanding of the lives and perspectives of others. We believe that this creates a greater number of stronger relationships between people, and that it helps people get exposed to a greater number of diverse perspectives... Simply put: we don't build services to make money; we make money to build better services."

Several years ago, we were often thinking of Facebook's power over private consumers' data, and questioning its ability to monetize the site. So the IPO event gives investors the chance to look closer into its financial details. In its IPO filing with the SEC, it is reported to have 845 million monthly active users, 2.7 billion Likes & Comments per day, 250 million photos uploaded per day and 100 billion friendships. It generates rapidly increasing revenue for the last three years, from $777 million up to more than $3.7 billion. The large part of revenue has come from advertising, where it increased from $764 million up to more than $3.1 billion. For the bottom line, the net income grew very fast in three years, from $230 million to $1 billion for now. In terms of cash generation, as fiscal year of 2011, the cash flow from operations is more than $1.5 billion al! ong with the free cash flow of $940 million.

So in terms of multiple valuation, at $100 billion valuation, Facebook is valued at 100x P/E, 106x free cash flow, 67x operating cash flow and 15.8x its book value. The valuation seems extremely high. But is that so? Then we should try to do the inverse discounted free cash flow for Facebook. The valuation of $100 billion would be equivalent to the assumption of 50% growth in its free cash flow for the next five years, and then 5% growth to infinity afterwards, with the discount rate of 10%. Comparing those assumption with the past operating data, the site has generated the consistent rapid increasing free cash flow over time, with the past three years annualized growth of 97.5%, so the assumption of growth for the next five years is nearly half of the past reality.

Year 2012 2013 2014 2015 2016 Terminal value
FV 1,410 2,115 3,173 4,759 7,138 149,901
PV 1,282 1,748 2,384 3,250 4,432 84,615
Valuation 97,711

And in terms of user valuation, the $100 billion with 845 million users would value each user at the worth of more than $118, including their private data posted in Facebook, their photos and their daily life events/comments as well as private messages. Using common sense, would you trade $118 to own the person private data including everything listed above? I personally do not think it would be the ridiculously high figure.

Nevertheless, in technology field, nobody knows what would happen right in the next day. Before, nobody knew Facebook would come along to successfully compete and surpass MySpace. As long as Facebook kept innovating to make better products to keep users coming back in their al! ready bui! lt strong network background, it would continue to grow, very fast and gradually becoming the larger and larger social network site and owns larger amount of private users' data around the world.

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