Although Face­book has recently been val­ued at $50 bil­lion and $65 bil­lion, a con­sen­sus value on the com­pany remains unclear. Some ana­lysts think it’s grossly over­priced while oth­ers think its value is bound to be higher. While we shall steer clear of a poten­tially con­tentious opin­ion on Facebook’s true value, we thought it would be an inter­est­ing exer­cise to assess the expec­ta­tions on Facebook’s rev­enue and growth to jus­tify its vary­ing valuations.

Rather than build a tra­di­tional val­u­a­tion model, we have used an unortho­dox approach. Using Google as the bench­mark, we have assumed that Google and Face­book have a sim­i­lar low dis­count rate and sim­i­lar mar­gins. These assump­tions allow one to use rev­enue as a proxy for earnings.

Google has a mar­ket cap­i­tal­iza­tion of $200 bil­lion, i.e. four times Facebook’s value. Yet Facebook’s rev­enues in 2010 were 16 times lower than Google’s. All things being the same, the only way one can jus­tify the cur­rent Face­book val­u­a­tions is if we expect higher growth of Facebook’s rev­enues than the Google benchmark. 

Fb1

Using a dis­counted cash flow model, I cal­cu­lated Facebook’s required growth based on an esti­mated growth of Google’s rev­enues. For instance, if the mar­ket expects Google’s rev­enues to grow at 20% a year for the next 10 years, Facebook’s rev­enues would have to grow at 46% a year.

The red line shows how much Facebook’s growth would have to be rel­a­tive to Google’s growth. In the wide range of rea­son­able sce­nar­ios that we have con­sid­ered, Face­book would have to grow between three and five times faster than Google over 10 years to jus­tify its $50 bil­lion val­u­a­tion. When we repeat this exer­cise for dif­fer­ent val­u­a­tion sce­nar­ios, the fol­low­ing trends emerge:

Fb2

  1. Between $50 bil­lion and $100 bil­lion, at a 10–15% expected Google growth rate, the pres­sure on Facebook’s growth increases by a mul­ti­ple of the expected Google growth. Thus, if we expect Google to grow at 15%, Face­book would have to grow by 36% for a $50 bil­lion val­u­a­tion and 47% for a $100 bil­lion valuation.
  2. By our esti­mates, Face­book would have to grow three to four times faster than Google over the next 10 years to jus­tify its present val­u­a­tion. If we assume that the expec­ta­tions on Google’s rev­enue growth are between 10–15% for the next 10 years, then the expec­ta­tion on Facebook’s growth are 30–50%. Google’s his­tory is instruc­tive in under­stand­ing if this could be done. Between 2004 and 2010, Google’s Q4 rev­enue growth was 43% com­pounded annu­ally. It did so by rapidly grow­ing at first and then steady­ing to a slower but robust growth mode. Face­book appears to be where Google was in 2004–2005. Thus, if Face­book is able to rapidly grow over the next four to five years and then slow down, it should still be able to meet its lofty growth expectations.

Fb3

Dr. Sid­dharth Shah
Sr. Direc­tor, Busi­ness Analytics

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