So What is Facebook REALLY Worth?

By Brian Shaw - September 19, 2012 | Tickers: AAPL, FB, GOOG | 0 Comments

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Recently, I wrote an article comparing the numerous similarities between the dot-com bubble a decade ago and the recent craze for new Internet-based startups.  Like the previous dot-com bubble, today's hot Internet stocks are a mix of viable long-term businesses and a number of flawed business models and short term fads.  Just as Amazon.com rose from the ashes of the dot-com bubble 1.0 from a decade ago, I ultimately concluded that Facebook (NASDAQ: FB) would similarly thrive after the dot-com 2.0 era ends.  While Facebook may be worth more a decade from now than it is today, that doesn't mean it is necessarily time to jump in with both feet and make it a core stock in your portfolio.  There is plenty of risk, and there is also plenty of debate about what the company is worth; after all, Facebook is down over 50% from its initial high of $45 reached after Facebook's IPO in May as noted in the chart below: 

With that context in mind, let's discuss Facebook's valuation a little further.

Valuation Step 1: The Fundamentals

As noted above, Facebook is trading at some pretty high multiples.   Even when you factor in Facebook's pristine balance sheet and $10.2 billion in net cash, the shares still seem expensive on the surface.  To make sense of this and attempt to translate whether the shares are over- or under-priced today, let's take a look at growth.

Valuation Step 2: Assess Future Growth

An investment in Facebook today only makes sense if you buy into the company's growth plan.  Will Facebook be able to monetize the power of its social network through increased advertising and more robust growth in mobile and search?  Can it take on Google (NASDAQ: GOOG) and continue to be a top-visited website, or will it fall into obscurity like MySpace and others?  If you doubt that Facebook can grow profitably, I suggest looking elsewhere for your next investment.

However, if you think Facebook can leverage its enormous user base and the fact that the company knows more about you than probably any company in the world (with the only possible exception being Google), then it is time to look deeper at how much Facebook's revenue and income can grow.  As noted above, analysts are expecting 27.2% growth over the next 5 years.  CEO Mark Zuckerberg is focused on addressing the mobile market, which took a big step forward when Apple (NASDAQ: AAPL) announced the new Facebook integration functionality embedded in the upcoming iOS 6 operating system.  With Apple appearing to be more friend than enemy at this time, many people are beginning to think that 27% growth is too low.  35-40% might be more realistic.  

Whether Facebook can grow at 27%, 35%, 40% or some completely different number (either higher or lower) is both the most important estimate in valuing Facebook and the least precise (unless your crystal ball works better than mine).   Given the high level of uncertainty, I'll lay out a number of valuation scenarios to at least attempt to establish a possible range of outcomes.

Valuation Step 3: Possible Share Prices

The projection of a company's future share price is complicated using even the simplest discounted cash flow models.  Factor in the number of assumptions built into how an emerging company will mature and evolve, and this article could easily be 20 pages long.  To keep this brief and high level, we'll keep the assumptions ultra-simple by focusing on GAAP earnings multiples:

• Growth assumptions: 20%, 27%, 35% and 40%
• Starting point: 2013 analyst estimated GAAP EPS - $0.63 per share
• PEG ratios: 1.0, 1.2 and 1.5 

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