Among the noteworthy IPOs in the last few years, many would consider Facebook (FB) to be one of the biggest disappointments, with the stock falling sharply from its IPO price of $38 a share, which implied the firm's valuation at $104 billion - making it the highest valued newly public company on record. Prior to the IPO, I had argued in an article that using aggressive estimates, the company had a fair value of $56 billion, and recommended shorting the stock if the underwriters priced it at close to a $100-billion valuation. Unfortunately for early investors, my prediction came true, with the stock price falling in the ensuing months to nearly half the listed price. At last check, the stock traded at just over $19 a share.
In the aftermath of the quarterly results declared by the company, with more information in the market, I have revised the assumptions of my discounted cash flow model leading to a change in my fair value estimate. This article presents the results of my revised analysis.
In the most recent quarter, the company reported revenues of $1,184 million in Q2 2012 compared to $895 million in Q2 2011, a growth of 33%. Income from operations was up a paltry 8% (on a non-GAAP basis). Operating margins were at 43%, compared to 53% in the same period last year.
In my initial analysis on FB, I had projected a 5-year aggressive growth rate of 50% using the post-IPO performance of Google (GOOG) and Baidu (BIDU) as a base. FB will most likely not live up to those lofty expectations and will significantly trail the 42% annual growth rate of GOOG and 65% growth rate of BIDU in the five-year period following the IPO.
Analysts on average expect the company to grow its earnings at an annual rate of 27%. I hold a slightly optimistic view and based on projected average return on equity of approximately 30% and a retention ratio of 1, I estimate a compounded annual growth rate of 30%. For years forecast 6 through 10, my growth rate projection of 15% annually remains unchanged.
On the operating margin front, I have slightly lowered my near-term estimates. When I last analyzed the firm, FB had reported operating margins of 46% - which have now declined to 43%. My model calls for near-term margins in the 40% to 43% range and these margins are expected to gradually decline over the next 10 years to settle at 30% in perpetuity. Capital expenditure needs were estimated by comparing the sales to capital ratios of the advertising and software services industries and a ratio of 1.5 was selected.
The important inputs of the model and the resulting valuation are shown below:
Bottom-Up Beta (high growth)
Bottom-Up Beta (stable growth)
Risk Free Rate
Equity Risk Premium
Cost of Equity - High Growth Phase
Cost of Equity - Stable Growth Phase
Average Growth Rate (Years 1-5)
Average Growth Rate (Years 6-10)
Stable Growth Rate
Present Value of FCFE in High Growth Period (Billions)
Present Value of Terminal Value of Firm (Billions)
Cash and Equivalents (Billions)
Capital Lease and Debt (Billions)
Value of Options (Billions)
Market Value of Equity (Billions)
Shares Outstanding (Billion)
As shown in the table above, my projected fair value for FB is approximately $15 a share. Trading at $19.3, the stock is overvalued by approximately 30%. In my opinion, the stock continues to make a good short candidate.
Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.