At this point it’s not clear whether Facebook will be a money machine like Google (GOOG), with a market value eight times revenue, or suffer from accelerated decrepitude like America Online (AOL), with a market cap less than revenue.
On August 24, 2010, David Gelles reported in the Financial Times that:
... an unnamed investor made what many may consider a good bet – he bought a small stake in Facebook, the fast-growing social networking site. However, as a private company, Facebook has not disclosed details of its financial performance and the $76-a-share the investor paid has raised eyebrows from Wall Street to Silicon Valley. The trade gave Facebook an implied valuation of $33.7bn ...
Within the span of months, Facebook’s implied market value went from around $5 billion to over $60 billion.
The same day, in August 2010, Andy Zaky made The Case for a $50 Billion Facebook. In this article he wrote that the lack of financial information hasn’t stopped:
... scores of Silicon Valley analysts from speculating on the company’s finances by evaluating the various trends in advertising revenue and user growth. Nor does it stop big investors from taking sizable stakes in the company in the hopes of getting handsome returns on a future IPO that some suspect could happen as early as 2012.
In the September 27 issue of Bloomberg Businessweek, Brad Stone wrote that Facebook “... is predicted to bring in revenues of $1.4 billion in 2010 ...” The question is: Can revenues predict Facebook’s market cap if the company goes public in January 2012?
BOARDROOM vs. SPACE STATION
There are at least two ways to predict how revenues affect market cap. The first deals with subtle and unobservable factors buried deep in financial statements. An example is my article on Why Airline Mergers Don’t Work: Scale is not a Blessing. Think of this as the view from the boardroom.
The second deals with none of these subtleties. Instead it studies the Value Revenue Ratio [VRR] of companies. An example of this approach is my paper on The Value/Revenue Ratio. Think of this as the view from Space Station.
Why take such a long distance view? First, the VRR simple to calculate. Second, it’s a useful way to bracket Facebook’s value with nothing more than Bloomberg’s $1.4 billion revenue estimate and a little statistical analysis.
THE VIEW FROM THE SPACE STATION
The following chart (click to enlarge images) is based on the VRR data for over 243,000 firms from January 1, 1950 through December 31, 2008. These beginning and end points bracket the entire useable history of the Capital IQ Compustat annual data available at Wharton Research Data Services.
The main take-away from this chart is the long-run average value/revenue ratio is 1.
SOME 2009 BENCHMARKS
The 2009 VRR numbers used in this analysis are based on 51 companies that will occupy the internet service market space with Facebook should it go public in 2012. All 51 of these companies have the same GICS, NAICS and SIC codes that will be assigned to Facebook. For the details on how industrial code sharing is used to identify competitors that occupy the same market space, see the audio slide show Who’s In My Strategic Group?
For these 51 companies the mean VRR in 2009 was 2.7. The standard deviation was 3.5. Several other relevant 2009 benchmarks are:
FACEBOOK’S 2012 MARKET VALUES
The following table reports the probabilities (in red) that Facebook’s market value (in green) will range from $7.0 to $56.0 billion based on projected VRRs (in blue) ranging from 7.0 to 8.0 in increments of 0.5. The company’s sales revenue is assumed to reach $7 billion by the end of 2011. This represents a sales multiple of 5 over the next 14 months.
The mean market value in the sample of 51 internet service and software companies was $5.26 billion in 2009. The standard deviation in value was $27.66 billion. In other terms, the unitized risk in this sample was 5.5. This number reflects the well known fact that internet service and software is a risky market space.
The Z statistics (in white) are based on Facebook’s implied market values, the internet service company mean value and standard deviation. One can verify the probabilities with the online Z Calculator.
WHAT’S FACEBOOK WORTH?
The chance that Facebook’s 2012 market value will equal its sales revenue is one in two. The chance its market cap will reach $50 billion is around one in twenty.
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