Previously, I've published my version of Facebook (NASDAQ:FB) valuation using multipliers. That analysis gave ambiguous results, and, thanks to some constructive comments, I came to the conclusion that Facebook, with its current stage of life cycle, level of profitability and business model, does not have close analogs at the moment. Therefore, I decided to use DCF modeling to figure out whether it makes sense to buy Facebook's shares at today's price, taking into account the specific parameters of this company.
Jumping ahead, I would like to note that the results surprised me.
First of all, here is the WACC calculation:
As the Risk-Free Rate of Return, I used the current U.S. 10-Year Bond Yield.
- I got the expected market return for the U.S. stock market from here.
It was not easy to determine the correct beta coefficient. According to Reuters, Facebook's beta is 0.68, which is true if we take into consideration the entire period during which Facebook's shares have been traded on the stock market:
However, if we look at the dynamics of its beta coefficient over shorter periods of time (e.g. over the last 180 days), we get the beta coefficient of 1.03:
The higher the beta, the higher is the WACC, and the lower is the fair value per share, based on the DCF analysis. Voluntarily willing to include the least favorable parameters for Facebook in my DCF model, I used the beta coefficient of 1.03.
When performing the DCF analysis, I used the following assumptions:
To forecast the company's revenue growth for the next 10 years, I used an exponential model that most closely matches the revenue dynamics of Facebook over the past five years. According to my forecast, Facebook's revenue will amount to $38 billion in 2017 (+ 38 YOY), and to $51 billion in 2018 (+ 34 YOY):
It is noteworthy that these figures almost exactly match the average analysts' expectations provided by Yahoo! Finance:
Source: Yahoo! Finance
- Facebook's average Operating Margin has been 40% over the past three years. However, in my DCF model, willing to analyze the least favorable scenario for Facebook, I assume that Facebook's operating margin will gradually decrease to the level of 35% due to the increased competition.
- As the relative size of CAPEX, I used the value of 2016, i.e., the maximum value for the previous three years.
Here's the model itself:
So, the DCF-based target price of Facebook's shares is $344, offering 122% upside! At that, it should be noted that the prognostic parameters used in the model are the least favorable for the company. Furthermore, I absolutely do not consider the probable cash flow that WhatsApp could generate by developing its digital payment services.
The result of the model is most sensitive to the WACC and the forecasted revenue growth of Facebook. Therefore, in order to find out how much these input parameters should worsen so that the DCF-based share price equals the current Facebook's share price, I used the valuation sensitivity table:
As you can see, the DCF-based target price of Facebook's shares will correspond to the current level in the case if the WACC increases to 12% (in my opinion, it is highly unlikely), and the CAGR of the revenue falls to 20.7% over the next 10 years, which assumes the revenue growth of only 33% YOY over this year (the lower bound of the analysts' expectations, according to Yahoo! Finance).
Putting It All Together
Even excluding WhatsApp, given the relatively high WACC and assuming not the most optimistic revenue growth of Facebook in the coming years, DCF valuation indicates more than 100% growth potential of Facebook's shares from the current level. In my opinion, this is tangible proof that Facebook is still very far from its peak.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.