Fair Value For Facebook Is Closer To $56B: Avoid IPO, Short The Stock

| About: Facebook (FB)
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Unless you have been living under a rock, you probably know that Facebook (NASDAQ:FB) has filed for listing on the stock exchanges and plans to raise $5 billion through its IPO, which is rumored to value the firm at $100 billion. I have several issues with the IPO, starting with the fact that Mark Zuckerberg (who I greatly respect) will dominate the company and the shareholders will have little control over the happenings at Facebook. I plan on discussing the management issues in a separate article. In this article, I will perform a discounted cash flow analysis of FB and determine the fair value for the company.

I began my analysis by reviewing the historical financials provided by FB in its S-1 filing. Some important financial information from the last 3 years is shown below.












Net Income




In addition, FB had $3.9 billion in cash and equivalents and no debt on the balance sheet. The company increased its revenue by 88% and net income by 65% in the last financial year.

To estimate my projected growth rate for the next 10 years, I evaluated the growth trajectories of Google (NASDAQ:GOOG) and Baidu (NASDAQ:BIDU). Google, in 2004, reported revenue of $3.18 billion. Last year, GOOG revenues had ballooned to $37.9 billion - an average growth rate of 42% annually. Baidu on the other hand grew its earnings at an annual rate of 65% over the last 3 years with its revenues increasing from $3.19 billion to $14.489 billion. Based on growth rates of GOOG and BIDU, I project FB to grow its earnings at an average annual rate of 50% during the next 5 years, followed by an average 15% growth rate in subsequent 5 years. My model assumes a terminal growth rate of 2%.

FB currently sports a very impressive operating margin of 46%. I find it highly unlikely that the firm will be able to maintain these impressive margins over its life. I have modeled a gradual decline in margins over the next 10 years with a margin of 30% in the tenth year. Capital expenditure needs were estimated by comparing the sales to capital ratios of the advertising and software services industries (Sales / Cap = 2).

Finally, FB reports that proceeds from the sale of Class A shares will not be received by the company. Mr. Zuckerberg plans on using the proceeds to pay taxes arising from option grants. I have assumed that $3.3 billion of the $5 billion will reach the company's treasury.

The important inputs of the model and the resulting valuation are shown below:


Bottom-Up Beta


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)


Cash from IPO (Billions)


Market Value of Equity (Billions)


As shown in the table above, I project fair value of $56.28 billion for FB. This calculation does not include the impact of employee stock options. Based on my rough estimate, the options would reduce the company's fair value by about $3 billion.

If the rumors are true and FB is indeed offered to the public at valuations closer to $100 billion, I recommend avoiding the IPO. I would wait for the first week bounce and then consider shorting the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.