Investing is nothing more than putting the odds in your favor since it's impossible to predict the future with precision. But based on thoughtful analysis, you can reasonably assume scenarios and their associated odds of happening. Based on this thinking, we'll analyze what you are betting on if you buy Facebook (FB) at the IPO price or higher.
To begin the analysis, we looked for the best comparable. We choose Google (GOOG) based on its monopoly-like market position, high margin business model, and advertising-based revenue model. Below is an assessment of how Facebook's business model compares to Google from the founding of each company.
Facebook needs to crank up the advertising machine to begin justifying the valuation:
Facebook also needs to generate much more net income to be comparable with Google and justify the valuation:
Average Revenue per User shows Facebook behind the curve, but this is expected as the company has only begun to monetize:
There is a massive gap between Average Revenue per User (ARPU) Between Google and Facebook. Over time, we think Facebook will greatly narrow this gap as the company unleashes new ways to monetize its user base such as placing ads on other websites, building a social search engine, and other things that haven't even been thought of yet. (We call this alpha).
We are less focused on Yahoo (YHOO), Zynga (ZNGA), or LinkedIn (LNKD) since they either are dying businesses (Yahoo), or have less analogous business models. But the point is that you need to believe that Facebook can meaningfully close the ARPU gap with Google to justify a $100 billion valuation in2012.
We also think Apple (AAPL) is a unique business model with unparalleled success, so we want to present some comparisons between all these companies. Below, we compare the business models of Apple, Facebook and Google.
All companies have amazingly profitable business. Look at these graphs and be amazed:
Importantly, Facebook will benefit from economies of scale as the company grows. And margins -- particularly operating and net income margins -- will expand from these levels. The high margin nature of the business deserves a premium valuation.
So here's where the rubber meets the road -- the financials and valuation. We created two scenarios, Base Case and Upside Case. Both assume massive revenue and earnings growth as we are favorably inclined towards the fundamentals of the business. However, the upside case assumes ARPU reaches $26 vs. only $21 for the Base Case (which is still aggressive!).
Below are the assumptions in our Base Case.
If you are interested in our Upside and Bear Case assumption details, just let us know and we'll send it to you.
Hopefully this helps you think about the bet you are taking by buying Facebook.