The Case for a $50 Billion Facebook

Includes: GOOG, MSFT, PG
by: Andy Zaky

Like many privately held companies, Facebook has always been very tight-lipped about its financial performance, only telling us that it went cash flow positive for the first time in September 2009, and that its user-base recently eclipsed 500 million subscribers. Yet, this doesn’t stop scores of Silicon Valley analysts from speculating on the company’s finances by evaluating the various trends in advertising revenue and user growth. Nor does it stop big investors from taking sizable stakes in the company in the hopes of getting handsome returns on a future IPO that some suspect could happen as early as 2012.

Based on a recent study released by eMarketer, Facebook is expected to bring in roughly $1.3 billion in revenue in 2010, nearly doubling the $665 million the research firm estimates it recorded in 2009. Yet, despite Facebook’s enormous revenue growth, it currently only brings in a meager $0.56 per 1,000 page impressions compared to the industry average of $2.43. Furthermore, according to current estimates provided by Second Shares, Facebook makes only about $2.60 per user on an annual basis, which is significantly lower than the $18 made by Google (NASDAQ:GOOG) or the $12 made by Aol (NYSE:AOL).

So while Facebook is poised to surpass Google with its 500 million users making it the most popular website on the net, some are concerned with Facebook’s ability to fully monetize its user-base, and question whether privately traded shares of the company might be overvalued. Facebook has yet to capitalize on its subscribers in a meaningful way and has made very little progress on the revenue per-user front.

Yet it's also important to remember that other Internet-based companies started in a similar way -- including Google -- and that Facebook could easily improve upon its anemic revenue per-user growth.

While the company has no immediate plans to make a public offering, shares of Facebook already trade on two private exchanges attracting investors of the likes of Microsoft (NASDAQ:MSFT), Digital Sky Technologies and Chinese billionaires. So what is Facebook really worth, and what might it be valued on IPO?

According to Next Up Research, private investors were valuing Facebook between $11.1 and $12.5 billion earlier this year. Today, they're valued at $24.9 billion, according to a similar analysis offered by Bloomberg.

And, according to Larry Albukerk, a specialist at EB Exchange Funds who privately brokers shares of Facebook, the company occasionally trades at an even higher valuation. He recently told MSN Money:

There are very large, sophisticated institutional investors who are buying at a $30 billion valuation.

Those are some big swings. Yet, Facebook investors are all too familiar with the huge volatility. When Microsoft took a $240 million stake in the company in October 2007, the purchase was based off a $15 billion valuation — the same valuation it had in early 2008 when Hong Kong billionaire Li Ka-Shing took the second of two $60 million stakes. But by 2009, Facebook’s value had dropped. A $200 million stake taken by the Russian technology firm Digital Sky Technologies in May 2009 put the company at a valuation of roughly $10 billion. That’s a $5 billion drop from the previous year’s valuation.

So are private investors getting overzealous in their assessment of the company or will these large stakes prove as lucrative as those who had the vision to get ahead of Google’s IPO? The answer to that question largely depends on Facebook’s ability to monetize its user base. 500 million subscribers is a staggering number for any company, especially when considering that Facebook already owns nearly half the world’s Internet users. Yet, as the financial community learned with YouTube, having a gaggle of users is only one part of the equation. The ability to make money on those users is key to determining value.

When discussing this issue with senior analyst Debra Aho Williamson at eMarketer, I got the sense that Facebook will probably be able to monetize its user-base more efficiently in the coming years as a result of an impending shift in Facebook’s business strategy. Though half of Facebook’s current growth comes from the blockbuster success of its self-serve ad platform, its future lies with big-brand advertisers who are starting to show tremendous interest in being able to reach customers through the Facebook business model.

Procter & Gamble (NYSE:PG), the world’s largest advertiser, continues to take a significant interest in Facebook, suggesting that other big brand names might soon follow. While Facebook’s self-serve ad platform has been responsible for much of its recent success, this pales in comparison to the type of revenue explosion Facebook will see from increased CPM rates offered by big brands.

Secondly, according to Williamson, Facebook will soon see a significant uptick in user-growth through international markets, which is very key in making the overall platform attractive to brand advertising. As Facebook reaches more users worldwide, internationally recognized brand names are inclined to become far more interested in reaching its customers through this near universal platform.

Despite the company’s massive install base, it’s still far outpacing Google’s growth in users. According to recent estimates, Facebook grew its user-base by 150% in 2009 versus Google’s 40% growth based on similar metrics. So even if the company doesn’t make immediate inroads in its CPM (cost per thousand page impressions) and CPC (cost per click) rates, user growth by itself is propelling much of the company’s 100% revenue growth.

And even if Facebook doesn’t substantially raise its revenue per user in the immediate future, the company’s staggering user growth by itself justifies a valuation of nearly $50 billion over the next several years. Facebook is expected to earn nearly $1.8 billion in revenue in 2011 and that’s based on a projected 600 to 700 million users. Google currently trades at a $150 billion market capitalization and the only thing standing between Google and Facebook is Google’s revenue per user. If Facebook were to produce similar revenue per user rates as Google, the company could potentially be worth upwards of $150 billion.

Finally, it is this potential to capitalize on such a huge user-base that will likely drive a lot of speculative demand for the company on IPO. Traders are already bidding the company up to $30 billion. In fact, when asking Paul Bard, director of research at Renaissance Capital, about the potential for a successful Facebook IPO, he noted:

Facebook could do an IPO tomorrow and the offering would be met with huge investor demand.

Renaissance Capital is the global leader in providing independent and investment management services on IPOs. Paul Bard, on his part, believes the company to be conservatively worth about $20 billion today.

Based on my conversations with some of the leading analysts in the industry, I think what investors will likely see on Facebook’s IPO is a rally not seen since Google’s public offering. Many investors missed out in getting ahead of Google’s meteoric stock surge, and Facebook will give investors a second opportunity to participate in a blockbuster IPO. Facebook is probably already worth $50 billion, and will likely march toward the $150 billion valuation over the next several years.

Disclosure:No positions