With the announcement of Facebook's (FB) IPO, analysts are valuing the company at an estimated market cap of $100 billion. Facebook has over 845 million monthly active users and is the most visited website on the internet. However, does this traffic warrant a valuation higher than blue chip companies such as Boeing (BA), Goldman Sachs (GS), Visa (V), and Disney (DIS)? The answer is a definitive no. In reality, Facebook's intrinsic value is closer to $41 billion (59% below consensus estimates).
The bullishness behind Facebook is not warranted through its economic fundamentals. Based on generous growth projections of 30% earnings growth per year, its discounted cash flow based market cap should be $41 billion*. In order to hold its $100 billion valuation Facebook's earnings would have to grow at an average pace of 57% per year for five years. That kind of growth for Facebook is unsustainable.
Facebook's strength is the size of its user base. On any given day, 425 million people either check Facebook through their computer or smart phone. However, these users add little to no contributions to the bottom line. At just 0.04%, the average Facebook ad click-through rate is slightly less than half of the average website on the internet (0.09%). Also as someone who uses Facebook and is familiar with the social media habits of their peers (16-30 year olds are largest and most demographic group on the site), users access Facebook to check updates and communicate with friends. As a result. users largely ignore ads. For online shopping consumers are more likely to click on ads from a Google (GOOG) search or other links from websites that share a similar topic as the purchased product (Example: espn.com for sports merchandise/tickets). Bulls argue that sponsors can use Facebook for PR and branding, but those pages are made for free and do little for Facebook's bottom line. Nevertheless, both direct ads and corporate Facebook pages are in general regarded as more annoying than informative to Facebook users as well.
Outside of advertisements, Facebook has limited opportunities for revenue growth. It cannot charge its customers because users will just migrate to another free platform to interact with friends (such as Google+ or a future "next Facebook"). Facebook can sell demographic data and page views to companies for research purposes, but growth in this sector is limited by potential privacy violation lawsuits and stiff competition in the data mining sector.
Social media outlets do provide value to both to society and investors. However, the steep valuation that Facebook is unwarranted versus its actual growth potential. Companies such as Google , Comscore (SCOR) and Vocus (VOCS) are viable alternatives to Facebook who are more efficient at generating advertising and data mining results. I recommend investors to buy Google and short Facebook after the initial euphoria related to its upcoming IPO.
* DCF formula uses an 11% discount rate and a 4% continuing value growth rate (generous in slow growth economy).
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GOOG over the next 72 hours.