Are Facebook valuations justified?

Recently I came across this article on Techcrunch on Facebook valuations reaching $75 billion and it got me thinking about the lofty valuations facebook has been commanding in recent times. Based on secondary market deals, it seems Facebook is round about $70 to $75 billion – A jump of almost $25 billion in 2-3 months (Goldman valued Facebook at$50 billion in October 2010. Just in Feb 2010, Facebook was valued at $9 billion.

See the chart below on Valuations of Facebook over the years (collated by ClickThrough )

Unable to understand what are the drivers behind these valuations as they seem just too big and not sure when will the investors be able to make money from these huge valuations. Did some maths quickly and compared it with some other equivalent listed companies. Following is the synopsis it :

1.Based on $70 billion valuation and 600 million users, each facebook user is worth $117

Worth to mention that there are no tangible assets which the facebook has here. Facebook reportedly made $500 million profit in the year 2010 which means around $1 for every user. Now if we take this data at its face

value it would mean that facebook would need to have 10 billion users pretty soon to be able to return $70 billion back to its shareholders in around 10 years or less (very rough NPV calculations). Practically this is not possible as we dont have 10 billion users on earth. So obviously facebook would need to start generating very high profits per user very quickly.Believing that Facebook could potentially capture 1 billion users, this would mean facebook would have to generate $10 per user in profits every year. If we assume that Facebook is going to keep its net margins impact then that means average revenue per user of $20 per year. I dont know whether its possible. I did not do research on Google but I dont think even Google generates $10 per user. Moreover, I dont think this valuation madness is going to stop soon. I think this might just keep going up and up and up and hence more pressure on profits per user.

2.  Based on the above revenue and profits figures, it seems Facebook is commanding PE multiples of almost 150.

Wow! havent heard about these PE multiple since the bubble of dot com. When investors are willing to give that kind of PE multiples, they are obviously expecting some kind of stupendous future growth. But how much for the next 5 years – 50%? 100%, 200%? To understand again did a quick maths and compared these figures with Google (online company similar to Facebook) and Apple (not a similar business model but a company growing stupendously). Surprisingly both Google and Apple command a similar multiple of 20-21(based on todays data) with very different growth rates. Google has been growing its profits at the rate of 26% in the past 3 years and apple has been growing its profits at the rate of 60% in the past 3 years. I know PE multiples are based on future growth rates buts in the lack future forecasted data, I am using historical data.

Lets compare Facebook PE multiples with Apple first. So for Apple – 60% growth rate and 21 PE multiple. This gives the PE/Growth ratio of 0.3 If we use the same ratio for Facebook then that would mean investors believe that facebook is going to grow its profits at the rate of 420% every year for the next few years. Wow – again not sure if thats possible. Not sure if Facebook did that in the past years on the smaller base.  This comparison seems to be too harsh. Now lets take the comparison of Google – 26% growth and 20 PE multiple giving PE/G of 0.76. Now if we use this ratio for Facebook, it would mean investors are expecting Facebook to grow its profits at the rate of 185% every year for the next few years. That is almost tripling profit every year – meaning 1.5 billion dollars in the year 2011. 4.5 in the year 2012 and 13.5 billion dollars in the year 2013. Again just seems too much  and too optimistic.

Based on the above two analysis, I have some serious doubts that investors would be able to make money from this investment in the long term. For me the investment seems more of a fad rather than some logical rationale behind it.

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Disclaimer: The views expressed in this article are my personal views and do not reflect the views of my employer.

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