Seeking Alpha
Profile| Send Message|
( followers)  

Edited By Adam Isaac

Facebook, Inc. (NASDAQ:FB) is the prime online social network in the world and currently possesses over 901 million monthly active users ("MAU"), more than 500 million daily active users ("DAU"), and over 125 billion user connections. Facebook users upload more than 300 million photographs daily and about 750 million photographs on every weekend. Users of FB click the "Like" button over 3.2 billion times daily, which lets Facebook track the products and services its users prefer. Moreover, the Facebook website hosts more than seven million applications by third parties, and it is one of the leading online display advertisers in the world.

Facebook IPO was one of the biggest in the recent times; FB shares were offered at a price $38, a price making the stock massively overvalued. At the moment, the stock is trading less than half of the IPO price. At the time of IPO, FB had earnings of $1 billion. With earnings of $1 billion, the company was valued at more than $100 billion, which puts its PVGO (present value of growth opportunities) at more than $90 billion. At the time of IPO, investors put too much faith in the future growth of the company. However, it seems the faith was misplaced, and the growth is slowing at the moment. In this article, I have made an effort to come up with a fair value for the stock. I have used discounted earnings model; the model makes certain assumptions, which will be explained in the following paragraphs.

Facebook is supposed to be in the hyper growth phase, but in realty, growth in the "new unique users" is less than 5%. Facebook's revenue growth also declined substantially, and the most recent earnings announcement showed a revenue growth of 32%; a much lower growth figure than the previous growth figures of more than 100% growth rate. Facebook earns revenues through two means; one is by displaying advertisements on its website and the other is the royalties from third-party software developers. FB is currently behind its main competitors Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) in terms of revenues per user; FB is generating $1.38 per user while Google generates substantially higher revenue of $9.16 per user. At present, Google offers better advertisement space and enables the advertisers to target customers based on their searches.

Coming towards the model, I have been a little generous with FB and have assumed a growth rate of 40% in revenues before they gradually decline to a stable growth rate of 5%. I believe I am being generous because internet advertising is a fiercely competed market, and there remains few growth opportunities for FB in terms of new "unique users". All of these factors leave little room for FB to maintain hyper growth in its revenue. Facebook will also have to invest more in the marketing, R&D and administrative expenses. I have assumed a declining growth structure in its expenses, which vary from 5% to 20%. In the model, a constant tax rate of 30% has been assumed, current provision for taxes by FB stand at almost 40%.

ProForma Earnings:

Reported Earnings

ProForma Earnings

2009

2010

2011

2012

2013

2014

2015

2016

2017

Revenue

$777

$1,974

$3,711

$5,195

$6,962

$9,259

$12,037

$15,046

$15,648

Costs and Expenses

Cost of Revenue

$223

$493

$860

$1,143

$1,462

$1,852

$2,407

$3,009

$3,130

Cost of Revenues %

29%

25%

23%

22%

21%

20%

20%

20%

20%

Gross Profit

$554

$1,481

$2,851

$4,052

$5,500

$7,407

$9,630

$12,037

$12,518

Gross Profit Margin

71%

75%

77%

78%

79%

80%

80%

80%

80%

Marketing and Sales

$115

$184

$427

$512

$615

$738

$812

$893

$937

Research and development

$87

$144

$388

$504

$656

$852

$1,023

$1,125

$1,181

General and Administrative

$90

$121

$280

$322

$370

$426

$447

$469

$493

Total costs and Expenses

$515

$942

$1,955

$2,482

$3,103

$3,868

$4,689

$5,497

$5,742

Income from Operations

$262

$1,032

$1,756

$2,714

$3,859

$5,391

$7,348

$9,549

$9,907

Operating Margin

34%

52%

47%

52%

55%

58%

61%

63%

63%

Other Expenses, Net

$8

$24

$61

$92

$137

$151

$166

$183

$201

Income before provision for taxes

$254

$1,008

$1,695

$2,622

$3,722

$5,240

$7,182

$9,367

$9,706

Provision for Income Taxes

$25

$402

$695

$787

$1,117

$1,572

$2,155

$2,810

$2,912

Tax Rate

10%

40%

41%

30%

30%

30%

30%

30%

30%

Net Income

$229

$606

$1,000

$1,835

$2,605

$3,668

$5,027

$6,557

$6,794

Net Profit Margin

29%

31%

27%

35%

37%

40%

42%

44%

43%

Net Income attributable to Class A and Class B shareholders

$122

$372

$668

$1,285

$1,876

$2,714

$3,821

$5,114

$5,435

Percentage Income attributable to Class A&B shareholders

53%

61%

67%

70%

72%

74%

76%

78%

80%

Earnings per share for Class A&B shareholders

Shares outstanding

2,140

2,140

2,247

2,359

2,477

2,601

Diluted Shares

2,278

2,346

2,417

2,489

2,564

2,641

Basic

$0.12

$0.34

$0.52

$0.60

$0.88

$1.21

$1.62

$2.06

$2.09

Diluted

$0.10

$0.28

$0.46

$0.56

$0.80

$1.12

$1.53

$1.99

$2.06

According to my earnings estimate, the firm should be able to generate $2.09 in EPS in the year 2017. I am expecting the company to triple its earnings within the next 5 years. To keep up with my expectations, Facebook has to demonstrate healthy profit margins.

Valuation:

For valuation purposes, I have used discounted earnings model where earnings are discounted at a discount rate of 10%. Facebook has established history of revenues and there are chances that the firm will carry on growing for a while.

Valuation

2012

2013

2014

2015

2016

2017

Earnings

$0.60

$0.88

$1.21

$1.62

$2.06

$2.09

Discount rate

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

Present Value Factors

0.91

0.83

0.75

0.68

0.62

0.56

Discounted Earnings

$0.55

$0.72

$0.91

$1.11

$1.28

$1.18

Terminal year Value @5% constant growth

$21.89

Discounted Terminal Value

$12.36

True Value

$18.10

According to the valuation model, FB stock should trade at $18.10. At the moment, the stock is trading at $18.98. The stock is slightly overvalued, and I expect the market to correct the mispricing soon.

Summary:

Facebook is a phenomenon, but in terms of being a good investment; it has disappointed the initial investors so far. Early investors made great profits, but IPO investors lost a big chunk of money. The stock was massively overvalued, and the current market price of the stock shows that. Facebook management will need to think of something fast to increase revenues in order to bring this price up. At the moment, I will not touch this stock until I see some measures by management to increase the revenue generation capacity significantly. In the long term, the stock may well get back up and regain the value it has lost, but in the short term, I do not have much faith in Facebook. While the stock looks more or less fairly valued, the negative sentiment is likely to drive it lower until it reaches the bottom.

Source: How Much Is Facebook Worth?