A typical valuation is based on a combination of market value comparisons of similar companies and the company’s potential to generate future earnings. It requires sophisticated spreadsheets with projections and value comparisons to arrive at what may seemingly be a reasonable price to pay. But, when the assumptions used become outrageously flawed, so does the so-called “vetted” and “reasonable” valuation. How many of us still remember the dot.com bubble of a decade earlier? As a valuation analyst, I actually did see those “vetted” valuations that priced companies at outrageous margins – all were done in fancy spreadsheets – but had one thing in common: outrageous assumptions.
Without getting deep into the spreadsheet assumptions, I will offer a few simplistic ways to assess Facebook’s valuation:
1. Look at the stock performance of RenRen (the Chinese Facebook) and FriendFinder (another social networking platform) since their IPOs less than a year ago. RenRen lost over 60% of its IPO price in a few months and has been unable to recover since. On the other hand FriendFinder has lost over 80% of its value and is now trading under $2 per share.
2. Calculate the value per active user across social platform companies. For example, LinkedIn with 135M users is trading at a value of $63 per user, whereas FB with 845M users and $100B valuation is valued at $118 per user.
3. Compare FB to Google. Google’s market cap is $200B and with revenues of $38B, that makes $1 of Google revenue worth $5.25 to an investor. While FB at $100B in valuation and $3.8B in revenue makes $1 of FB revenue be worth $26 to an investor. Granted that FB has potential for growth – however, the inherent assumption is that FB has to grow organically at least 20% every year for the next 10 years to justify its valuation. While 20% may not be high for an early stage company, I have never seen a company do so for 10 years straight.
4. Assess the disruption factor. Given the unproven nature of the social networking platform as a revenue hotbed, a fresh way to assess its potential value is by asking a simple question – “If FB ceases to exist, how will that impact consumers of the company vs. if Google ceases to exist?” Reframing the valuation paradox in terms of disruption factor can shed light into the potential value. Since a fundamental tenet of valuation is value comparisons across competitors, in an unproven industry it may be hard to do so – however, we can get a glimpse of the truth by assessing the disruption factor. If you think Google will disrupt your life far more than Facebook, then Google has more intrinsic value than FB. Over the long term, valuations tend to converge to company’s intrinsic value and therefore, it can be a good yardstick to measure current valuations against. With this rationale, each $1 of FB revenue will be worth LESS to an investor than each $1 of Google revenue in the long-term. Since today it is the opposite, this phenomena will cause FB’s market cap to come down over time.
5. Review recent valuations of FB. Just a year ago, FB was valued at $50B and only 2 years ago at $10B. While FB’s successful monetization of its user base can explain the valuation change since 2 years ago, however, I can hardly recall anything significant changing in the past 12 months to warrant doubling its value. This may be indicative of the IPO mania driving its valuation to the roof.
While any of these factors in isolation will not be sufficient to draw any conclusions, there are too many warning signs to be ignored. Sometimes the sophisticated spreadsheets can miss the target when the assumptions go unchecked.
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