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.
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:
- 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.
- 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.
Dr. Siddharth Shah
Sr. Director, Business Analytics