Facebook (NASDAQ:FB) published their earnings last week. Their revenue was 12 cents a share, and their earnings were -8 cents a share, due to "$1.3 billion of share-based compensation and related payroll tax expenses." Not surprisingly, the stock tanked about 15%, to $23.68 a share.
There's the argument that Facebook is not well managed, facebook.com is a fad, they won't be able to monetize their users, worries about the upcoming employee share lockup expiration and so on and so forth. You can read the bearish arguments elsewhere on the internet. But I believe that Facebook is in fact deeply undervalued. To see how, let's compare Facebook to Google (NASDAQ:GOOG).
First, assume that Facebook, like Google, will make most of its revenue from advertising, i.e. users clicking on advertisements. Let's establish a point of reference. If you set up an account at adwords.google.com, you can see how much the current bids for different keywords. For example, here are the CPCs (cost per click) for the following keywords:
buy skinny jeans
get new wallet
For example, this means that if you Google 'new wallet', and click on a link to the side ("FOSSIL® Vintage Classics"), then bam! Fossil pays Google $2.25. I don't know how to get the average CPC over all of Google's advertisement links, or how many clicks Google is getting from its ads. But I think that $1.00 is a nice, round, conservative estimate, and I will assume that Facebook will get about the same CPC.
What will Facebook's operating margin be? Although it looks to be falling, perhaps I can assume that once they become more mature, their operating margin will become similar to Google's (33%), which is lower than what it is today. Just for argument's sake, to make my estimate more ridiculously conservative, say that Facebook's operating margin will be 20%.
So, by these conservative estimates, Facebook will make $.20 per click; multiply that by 500 million daily users, and Facebook is making on the order of $100 million times the average number of clicks per user. In other words, if users on average click one ad per year, Facebook makes $100 million. If users on average click ten ads per year, Facebook makes $1 billion.
At a P/E of 20, Facebook is worth $2 billion times the average number of clicks per user per year.
At this rate, Facebook needs only 25 clicks per user per year, or, on average one biweekly click per user, in order to justify its current valuation of $50 billion. At one click per week per user, Facebook's valuation shoots up to $100 billion, or twice its current valuation. Let me stress again that my estimates of profit per click are very conservative.
Lastly, the issue obviously comes up of whether Facebook will be able to get users to click at least 25 ads per year. I think the answer is that Facebook will have no problem doing so. I have no special insight into what kind of features Facebook is implementing to quietly get users to click more ads, but there are certainly no shortage of ideas and ways to implement them, and one can see early proof of higher mobile ad clicking.
Listening to the earnings call from last week, it sounds like Facebook is really hard at work at implementing these features and implementing them well, while focusing on user experience. I think that the possibilities are really endless for Facebook.