Reverse Engineering Facebook’s Valuation

Back in January, Goldman Sachs’s investment in Facebook at an

implied valuation of $50 billion caused quite a stir. While some felt the
valuation was reasonable[1], many investors balked at such a massive
evaluation, which exceeds the market cap of long-established tech
giants such as Yahoo and eBay. A poll of Bloomberg users back in
February revealed that 96% believed that Facebook was overvalued at
this price.[2] The recent news that General Atlantic is buying an 0.1
percent share of Facebook at $65 billion will surely reignite this
debate.[3]

Since Facebook is a private company (for now, at least)[4],

financial information on Facebook is hard to come by, but this hasn’t
stopped many in the blogosphere from trying to make sense of the
recent Facebook valuations. Most of the analysis of the Facebook
valuation has been fairly qualitative, with observers making broad
claims about the company’s extensive user base and its potential to
exploit the hours those users spend on the site daily.[5] The quantitative
attempts to value Facebook that have been undertaken, such as the
impressive effort by Trefis which pegs Facebook at $45 billion[6], are
based on a fair amount of estimates, projections, and guesswork.
There simply isn’t enough good, hard data out there about Facebook to
do a rigorous valuation.

With this in mind, an interesting way to make sense of

Facebook’s valuation is to utilize the one hard number we do have -
$65 billion – and to reverse engineer it. What are the multiples implied
by such an enormous valuation? Are these implied values reasonable?

Since they’re easier to compute, let’s start with the multiples.

From the valuation, we know Facebook’s implied market cap, and if we
use the numbers from Trefis, we can roughly estimate Facebook’s
enterprise value at around $63 billion. Around the time of the Goldman
deal, documents leaked that revealed Facebook raked in $1.2 billion in
revenue and $355 million in earnings during the first 9 months of 2010.
[7]
In addition,If we project this out straight for full year revenues and
earnings of $1.6 billion and $475 million, this gives Facebook an
EV/Revenue of 52.5x and a P/E ratio of about 137.

How do these numbers stack up to some of Facebook’s competitors?

While P/E ratios above 100 for heavily traded companies are certainly
not without precedent; OpenTable is currently trading at a P/E ratio of
nearly 147, for example. However, such huge ratios are generally met
with great skepticism with investors, and OpenTable is no exception.[8]
As for EV/Revenue, NeXtup Research’s October 2010 report found that
a group of similar companies such as Google, Yahoo, Xing and Mixi
(Japan’s leading social networking site) had a median EV/Revenue
multiple of 3.4x, with a group high of 22.8x. Thus, Facebook’s
EV/Revenue multiple is more than double its closest competitor, and
an order of magnitude greater than most.

Looking at these numbers alone seems to imply that Facebook is

drastically overvalued. However, thinking a bit deeper about these
numbers, we arrive at another fundamental problem in valuing
Facebook: the unparalleled growth, user base, and brand name that
make the company so unique render comparables analysis practically
useless. Since companies like Yahoo and Google are much further
along in their corporate growth cycles, comparing them to a company
like Facebook doesn’t make a lot of sense. On the other hand,
comparing them to similar social networking sites like Mixi doesn’t
really work either. Mixi already controls 80% of the Japanese market,
and doesn’t have much hope in expanding elsewhere, whereas
Facebook has a truly global reach, with 70% of its users residing
outside the US. Indeed, it’s Facebook’s combination of a Google-like
web presence and startup-like growth potential that makes it so
valuable, and which ultimately may justify such a hefty valuation.
Besides, those Goldman bankers couldn’t be wrong, right…?

References:
[1] http://doctordisruptive.wordpress.com/2011/01/03/facebooks-50-
billion-valuation-that-sounds-reasonable-even-cheap/
[2] http://www.ibtimes.com/articles/107909/20110202/facebook-
overvalued-at-50-bln-bloomberg-s-global-poll.htm
[3] http://www.cnbc.com/id/41892971
[4] http://mashable.com/2011/01/03/facebook-ipo-may-2012/
[5] http://www.sytaylor.net/2011/01/16/is-facebook-overvalued-will-it-
fail/
[6] https://www.trefis.com/company?hm=FBOOK.trefis#
[7]
http://nymag.com/daily/intel/2011/01/goldmans_leaked_details_on_fac.
html
[8] http://www.intelligentspeculator.net/investment-talking/trouble-
when-trading-high-growth-stocks-open/