Valuing Facebook Against Its Peers: Can A Case Be Made For The Stock?

May.20.12 | About: Facebook (FB)

The hype surrounding the Facebook (NASDAQ:FB) IPO resembled something seen in the heyday of the dot-com era, with the fervor reaching a fever pitch on Thursday, May 17, the day before Facebook started trading on the NASDAQ. The IPO was priced almost perfectly, as the stock did not see a huge pop, meaning that the underwriters did not underprice it, thus leaving money on the table for the company. However, the stock almost fell through the $38 IPO price, and the underwriters were forced to step in and defend the stock.

With the IPO now complete, investors can begin to look at Facebook and value it just like any other company. That is what we aim to do in this article. We will be comparing Facebook to several of its peers to see if a case can be made for investing in the stock. We chose 3 peers in the technology sector: Google (NASDAQ:GOOG), because it is seen as Facebook's primary competitor in the social networking space. Apple (NASDAQ:AAPL), because it is seen as the standard against which to compare high-growth companies to. And LinkedIn (NYSE:LNKD), because the company is arguably the public company whose business most closely resembles that of Facebook. For the record, all of our financial figures presented in this article, unless otherwise noted, are taken either from the most recent 10-Q filings of Apple, Google, and LinkedIn, or Facebook's final prospectus filed with the SEC.

Earnings Valuation: It's All Relative

Unlike many of the social companies that have gone public in the past year, Facebook has posted consistent, and growing profits for the past several years. But, Facebook has gone public at a much higher valuation than the established companies in the sector that we are comparing it to. To arrive at our trailing 12-month earnings for the 4 companies in question, we subtracted out the prior year's earnings and added in the most recent quarter's 2012 earnings.

Adjusted Trailing-12 Month Earnings and Valuations

Company Facebook LinkedIn Google Apple
Trailing 12-Month EPS $0.43 $0.15 $33 $33.58
Closing Price, May 18, 2012 $38.23 $99.02 $600.40 $530.38
Trailing P/E Ratio 88.91x 660.13x 18.19x 15.79x
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Based on the data above, Facebook's valuation is high, but not extreme. LinkedIn, arguably Facebook's closest peer, trades at a P/E ratio of over 600. And the rest of Facebook's social peers are either just beginning to reach profitability, such as Groupon (NASDAQ:GRPN), or are still unprofitable, such as Pandora (NYSE:P). However, Facebook trades at a large premium to both Apple and Google. Does it deserve to trade at such a premium? With high P/E ratios, there is an expectation of high growth as well. So how does Facebook compare to its peers on that basis?

Historical Annual Diluted EPS Growth Rates

Company CAGR 2011 2010 2009 2008 2007
Facebook 66.31%* (3-year) $0.46 $0.28 $0.10 -$0.06 -$0.16
LinkedIn 105.13%** $0.11 $0.07 -$0.10 -$0.11 $0.00
Google 17.50% $29.76 $26.31 $20.41 $13.31 $13.29
Apple 47.76% $27.68 $15.15 $9.08 $6.78 $3.93
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*Facebook's CAGR was calculated using a 3-year period, as CAGR cannot use negative income (Unlike LinkedIn, Facebook posted a net loss in 2007, thus disqualifying net income as a possible metric to use).

**LinkedIn's CAGR reflects the growth in net income itself, which for 2007 was 328,000, as CAGR cannot be calculated using a starting point of 0.

From a historical perspective, it would seem that Facebook deserves to trade at a premium to the market and its peers Apple and Google (arguments can be made for the fact that Apple is trading at a large discount relative to its growth, but that is beyond the scope of this article). And while the company's growth may trail that of LinkedIn, a drop to 66% growth from 105% is much more acceptable than paying 660 times earnings for 105% growth. We know Facebook has grown earnings much faster than either Apple or Google in the last several years, what is more important is where the company is going. How much are we paying today for Facebook's growth this year and next?

Facebook Estimates

Q1 2012 2012E 2013E
Revenue $1.058 Billion $5 Billion $6.5 Billion
EPS $0.09 $0.49 $0.60
Revenue Growth Rate 44.73% 34.73% 30%
EPS Growth Rate -18.18% 6.52% 22.45%
Forward P/E N/A 78.02x 63.71x
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A look at Facebook's growth rates reveals cause for concern. Per the financial results included for the first quarter in the company's prospectus, revenue growth was just under 45%, compared to Facebook's historical annual revenue growth rate of 89.22% for the past 5 years. And earnings actually dropped 18% over the previous year's levels, as the company ramped up spending. For 2012 as a whole, the Reuters consensus estimate calls for 49 cents in earnings, representing anemic growth of just 6.52%. And while earnings growth is set to rebound to over 22% in 2013, that is still a far cry from the 60%+ growth rates that the company has historically seen. Revenue growth is set to slow as well. However, once Facebook reveals just exactly how it intends to monetize its mobile users, it is possible that consensus estimate for revenue and earnings will rise. But for now, it seems that Facebook's best growth days are behind it, and for a stock valued at almost 89 times earnings, that is a negative. We now review the estimates for Facebook's 3 peers: LinkedIn, Google, and Apple.

LinkedIn Estimates

Q1 2012 2012 2013
Revenue $188.456 Million $0.9 Billion $1.3 Billion
EPS $0.04 $0.65 $1.19
Revenue Growth Rate 100.63% 72.35% 44.44%
EPS Growth Rate 140.09%* 490.91% 83.08%
Forward P/E N/A 152.34x 83.21x
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*Because EPS in Q1 2011 was $0.00, we calculated growth using net income.

LinkedIn's growth is set to accelerate rapidly in 2012, with EPS set to grow nearly 500% in 2012, before decelerating to "just" 83% in 2013. Revenues are set to grow nicely as well. LinkedIn may be a stock deemed by many to be expensive, but the company has the growth to support its valuation, in our opinion. We turn now to Google and Apple.

Google Estimates

Q1 2012 2012E 2013E
Revenue $10.645 Billion $35.5 Billion $42.3 Billion
EPS $8.75 $43.42 $50.63
Revenue Growth Rate 24.14% -6.34% 19.15%
EPS Growth Rate 58.8% 45.9% 16.61%
Forward P/E N/A 13.83x 11.86x
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Per Reuter's estimates, Google is set to actually post lower revenues in 2012 than it did in 2011, when it posted $37.905 billion in revenues, per the company's 10-K filing. Earnings however, are set to grow in 2012 from 2011 levels of $29.76 in EPS, implying that Google's margins will grow, thus mitigating the impact of a revenue decline. In any case, revenue growth is set to rebound in 2013.

Apple Estimates

Q2 2012 2012E 2013E
Revenue $39.186 Billion $162.4 Billion $195.1 Billion
EPS $12.30 $46.99 $53.90
Revenue Growth Rate 58.86% 50.02% 20.14%
EPS Growth Rate 92.19% 69.76% 14.71%
Forward P/E N/A 11.29x 9.84x
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Based on the estimates above, Facebook is set to post higher growth in 2013 than either Apple or Google. However, it is undeniable that the company is more expensive on a P/E basis than either Apple or Google. LinkedIn is more expensive than Facebook, but it is also set to grow at a faster pace. The question investors must ask themselves is how much are they willing to pay for growth? For some, the premium in Facebook stock will be worth it. And for others, Facebook is simply too expensive.

Cash Valuation: What's A Dollar Worth?

Every single company we are profiling in this article is flush with cash, a common feature in the technology sector. Facebook's IPO, per its final prospectus, brought in $6.76476 billion in cash to the company, bringing the total amount of cash on its balance sheet to $10.67476 billion. That amount, however, does not take into account the cash that will be paid to acquire Instagram (the acquisition is being funded with a mix of cash and stock). Going forward, our valuation for Facebook on a cash basis will include the $300 million in cash being paid to Instagram. In addition, data for Google includes the $12.5 billion in cash that the company is paying for Motorola Mobility (NYSE:MMI). As a reminder, net cash per share is calculated using balance sheet data from each company's latest 10-Q filing (or Facebook's final prospectus).

Net Cash Per Share
Facebook LinkedIn Google Apple
Net Cash $10,374,760,000 $620,807,000 $31,361,000,000 $110,176,000,000
Shares Outstanding 2,138,085,037 111,310,000 330,136,000 944,893,000
Cash per Share $4.85 $5.57 $94.99 $116.60
Price/Cash Ratio 7.88x 17.78x 6.32x 4.55x
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On a price-to-cash basis, Facebook's valuation is in the middle of the pack. However, it is still not as cheap on this basis as Google or Apple. All of these firms are cash flow positive, and it is important to determine where Facebook trades on a price/operating cash flow basis, relative to its peers, because it allows an investor to judge how much cash each company generates from its business that it can use to further invest in growing its markets, and ultimately increase profitability. We will arrive at an adjusted trailing free cash flow figure by deducting first quarter 2011 free cash flow and adding back in first quarter 2012 free cash flow.

Price/Operating Cash Flow Analysis

Facebook LinkedIn Google Apple
Trailing Operating Cash Flow $1.645 Billion $170.082 Million $15.087 Billion $53.068 Billion
Operating Cash Flow Per Share $0.76 $1.52 $45.69 $56.16
Price/Operating Cash Flow 50.30x 65.15x 13.14x 9.44x
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Once again, Facebook finds itself in the middle of the pack. The company seems like a value when compared to LinkedIn, its closest peer. And yet, when compared to Google and Apple, the company seems wildly overpriced, continuing a pattern that has been prevalent throughout our valuation analysis. There is, however, one element that has been overlooked, and that is history.

Historical IPO Valuations: Is Facebook a Value Stock?

Much of the criticism of Facebook's valuation stems from comparisons to companies such as Apple and Google, which trade at much more "acceptable" valuations than Facebook. But there is a large caveat that many are ignoring in that statement. So far, Facebook has been public for one day, whereas Apple and Google have been public companies for years. They have had time to grow into their valuations, and Facebook has not.

From a historical standpoint, Facebook is not overvalued at present levels. The company went public at just under 89 times earnings, and 20.33 times its trailing revenue. By comparison, Apple and Google were more expensive at the time of their respective IPO's. In 1980, Apple went public at 102 times earnings and 25 times sales. And when Google went public in August 2004, the company priced at 9.9 times trailing revenue, and at 118.06 times trailing earnings (data is based on Google's S-1 filings with the SEC). On a price-to-earnings basis, Facebook made its public market debut at a lower valuation than either Apple or Google. By historical standards of Silicon Valley, Facebook's valuation is not outrageous. And unlike almost every other social company, Facebook has a history of profitability. And even though the company may face an uphill battle to grow future profitability, due to the risks of being unable to monetize its mobile users, Facebook's path forward to profit growth is much clearer than that of many of its social peers.


So is Facebook a buy? Its valuation makes the answer unclear. Facebook is much cheaper than LinkedIn, its closet peer, and yet its growth, both historical and projected, is slower than that of LinkedIn. The company is more expensive than either Apple or Google, yet went public at a lower P/E ratio than both Apple and Google, and a lower price/sales ratio than Apple, seen by many investors as the gold standard against which to measure newly public companies. However, the company is facing a number of challenges, and its growth is set to slow in the quarters and years to come.

Would we recommend Facebook shares to readers? The answer is a very qualified yes. While we bough the stock when its made it debut, initiating a small position near $38, we would recommend the stock only to those investors that accept the fact that they will most likely have to wait at least several years for their investment to be profitable. We are prepared to wit, but other investors may not, and that is perfectly understandable. Facebook will grow its sales and earnings, but the company's best days are likely behind it. Unless you are prepared to wait for the company to grow into its valuation, and are willing to accept the fact that the stock could see declines for some time as investors begin to see the company through something other than rose-colored lenses, the stock is not a buy.

Disclosure: I am long FB, P, GOOG, GRPN. We are long shares of GOOG via a mutual fund that assigns the company a weighting of 2.23%. We are long shares of GRPN via our holdings of GSV Capital.