Will Facebook Ever Fundamentally Support Its $170 Billion Market Capitalization?

Feb.17.14 | About: Facebook (FB)

Facebook (NASDAQ:FB) shares reached an all-time high at $67.58 last week, giving it a market cap in excess of $170 billion. Yet, considering its $6.1 billion in trailing 12-month revenue, it's obvious that Facebook is valued for the future, and not necessarily today. However, the most significant question for Facebook investors might be whether that future can ever support its current price?

How to determine Facebook's upside?

In the early 2000s, technology giant Google (NASDAQ:GOOG) was considered primarily an Internet-search company. Yet, fast-forward 10 years and Google has transformed itself, now offering mobile software, social media, search, self-driving cars, and has a presence in just about every industry possible throughout the internet.

With that said, who's to know what Facebook may become, but as of now, Facebook is a social-media company that creates its revenue mostly from advertising. Therefore, in determining Facebook's "potential" we can acknowledge that it may in fact branch out into other ventures, but like Google, the core business of Facebook will always remain social media and advertising. It is that business, which will remain the bulk of Facebook's fundamental upside.

Therefore, before we begin there are three things you must understand:

1. This is speculative. We are trying to determine if it's possible for Facebook to fundamentally support its current market cap based on the business today and how revenue is created.

2. Advertising is 90% of sales. Thus, it will remain 90% in our projections.

3. Average revenue per user (ARPU) is impossible to predict. Therefore, we are using a best-case scenario.

4. We are looking at three specific revenue-generating businesses for Facebook: Its core advertising business, Instagram, and video advertising.

How many users and revenue-per can Facebook earn?

Facebook reported 1.23 billion monthly active users in its last quarter. The U.S. and Canada accounted for about one-sixth of those users, 201 million, but had without question the highest ARPU at $6.03, meaning nearly half of the company's quarterly revenue came from this small population.

The company's other users per location and ARPU were as followed:




282 million



368 million


Rest of the World

376 million


Click to enlarge

As you can see, Facebook is far behind in monetizing the rest of the world in comparison to North America. But, to many, this can be processed as upside, which is where the bulk of our fundamental-upside conversation will lie.

To explain, in biotechnology when we invest in a company we determine a product's chances to succeed in clinical trials and then its peak sales potential if approved when valuing the company. So, in regards to Facebook, let's figure a peak MAU potential at about two billion.

Now, we are using two billion for several reasons. First, it's a good ratio of the seven billion total world population, taking into account underdeveloped countries, the assumption that children are not on Facebook, and that peak saturation levels in the U.S. are now in effect. Not to mention, two billion is a nice big number that's easy to use.

Like I said, this is a best-case scenario!

So, if Facebook is going to gain two billion MAUs, let's see where such user growth could be created. And while we're at it, let's go ahead and apply a "peak" ARPU to these regions with the understanding of current ARPUs. Once more, keep in mind; this is a best-case scenario!



U.S. & Canada

210 million



350 million



940 million


Rest of World

500 million


Click to enlarge

First, for some notes:

U.S. & Canadian growth is getting more difficult to achieve, and my model assumes nearly 60% of every person in the U.S. becomes a MAU. Given the fact that ARPUs have increased over the years, $15 would be a good target, although very difficult to reach.

European user growth has also slowed, but the potential growth in Asia and in the rest of the world is large. However, with Asia and rest of the world there are a lot of third-world underdeveloped countries that scrape for the bare necessities, much less consistent Internet connection. Therefore, 1.44 billion users total in these regions would be extremely difficult, and while a $6 ARPU in Europe is likely possible, it's a far stretch in Asia and in the rest of the world. However, Facebook may surprise me, and as I've said repeatedly, this is a best-case scenario.

So, under this particular model, Facebook's advertising revenue could reach nearly $14 billion. However, I'd like to note that this does not account for the speed of mobile growth and its much lower $1.31 ARPU. Still, we'll use $14 billion in this model!

What about Instagram? What's is worth?

Now that we have Facebook's core business, let's move on to Instagram, a photo sharing service that saw its MAUs rise to 180 million in Facebook's last quarter compared to 90 million in the year prior.

However, with Instagram the problem is that advertising becomes more difficult, as users are simply scrolling pictures rather than news feeds, which is likely why Facebook hasn't added ads in photo albums or monetized Instagram. Yet, if there's a will then I'm sure that Facebook will find a way, and while Instagram does not have the same appeal as Facebook to all users, I think most could see users reaching 400 million based on its current growth. Then, if we apply a $2.00 ARPU, which is likely very high given no revenue dollars yet from the service, it is possible for Instagram to create $800 million in peak annual revenue.

The big catalyst: Video Advertising!

Next, video advertising is what's most interesting to me, a service that's supposedly in the works right now.

Reportedly, Facebook will sell 15-second TV-style ads on its site, charging between $1 and $2.5 million per day. With each paying customer Facebook will provide a day's worth of video advertising.

Unsurprisingly, there are many who are skeptical of whether this plan will work, but to give you an idea of just how lucrative this could become, I want you to consider the Super Bowl. The recent bloodbath of Seattle beating Denver was seen by 111.3 million people, making it the largest audience in American television history. And for that viewership, advertisers paid $4 million for a 30-second slot.

With Facebook, it has 10 times more monthly active users as those who watched the Super Bowl and provides advertisers with a whole day of ads rather than one 30-second slot. Need I say more?

Essentially, this could be huge for Facebook! And in my opinion, the demand will be huge. Thus, if Facebook "eventually" runs six ads per day at $2.5 million, that's another $5.5 billion a year.

What's Facebook worth on its best day?

With all things considered, Facebook could create $27.5 billion in peak sales based on a two billion-person user base. Moreover, if we assume that these services will account for 90% of future revenue, like the company's last quarter, and then peak sales could be closer to $30.5 billion, which is the number, we'll go with.

Therefore, is this enough to fundamentally warrant Facebook's market capitalization? To answer that question we could look to Google, which trades at 31 times earnings and 6.7 times trailing 12-month sales. However, these multiples may not be fair for a company being valued at peak potential, as Google continues to grow at a double-digit pace, meaning it too is valued in some ways on its outlook.

Therefore, Microsoft might give us a better idea of how a large technology company should look, trading at 3.7 times sales and 14 times earnings, which is very consistent with Apple. With that said, Microsoft (NASDAQ:MSFT) has industry-leading margins, including a profit margin of 27.3% over the last year. So far, Facebook has proven itself to be highly effective, thus we will use the same profit margin to predict $8.3 billion in peak profit, which is also very generous.

So, at the end of the day, and after we're done crunching all these very bullish numbers, a P/E ratio of 14 on $8.3 billion of net income equals $116.2 billion and 3.7 times $30.5 billion would be $112.8 billion, meaning that Facebook at its peak is worth somewhere around $115 billion, or $45 a share, assuming no dilution occurs.

With that said, it is really hard to find another $56 billion worth of upside in Facebook to validate its $170 billion market cap. Right now, it appears that investors are only speculating about the future, but with all investments, sooner or later the fundamentals always win. Now, it is possible that Facebook gets its ARPUs up to $15 throughout the world, runs 15 video ads a day, becomes a viable competitor with Google in search, and offers another dozen or so services with a billion dollars in revenue each. Then, Facebook may have another $10-$15 in fair value upside.


I think it's important for readers to understand that I am not a Facebook bear, nor am I short. In fact, following its July 2013 quarter (at $35) I tweeted that Facebook would touch $50 in 10 weeks, which I was right, and then after this last quarter I said it would reach $68. I was basing these targets off of momentum, and an understanding that demand was very high for these types of stocks, but it didn't mean that Facebook was worth that price.

The problem is that when growth becomes more difficult, or is flat, and if Facebook's fundamentals don't support the premium multiples, then its stock will fall drastically. With that said, I think Facebook is a great company, one that just so happens to be operating in a time of bubble-like premiums for social media stocks. Right now, the company is clicking on all cylinders, but as we're talking about peak potential investors must remember that Facebook must maintain a delicate balance of not becoming too promotional on its site.

Hence, if Facebook becomes a source of advertising-only, and news feeds become saturated with far more ads than friend posts then users will likely seek other social engagement, as will investors. Therefore, $30.5 billion in peak revenue is not a slam dunk for Facebook, and neither is $45 a share. In reality, we could be looking at long-term downside far greater than 50%, but that doesn't mean that momentum can't take shares even higher short term. Thus, my closing words of advice are to be careful, understand the peak potential of this company, and that the easy gains are more than likely a thing of the past.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.