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Facebook Stock Price Gravitates to Analysts’ Average Value Estimate of $28: But Which Valuation is Right?

Companies / Tech Stocks May 25, 2012 - 02:38 PM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticlePost-IPO the experts are jostling for space on Prime Time; many are saying they all knew Facebook was outrageously overvalued; or as Barry Ritholtz and Peter Schiff put it, “It’s the Valuation Stupid”. None are saying $38 is cheap these days.

Some say they felt it in their bones. Some say it’s all about the alignment of Jupiter with Mars or perhaps the Fibonacci constellation; some are talking about Fair Value as is $38 just wasn’t “fair”. Theories abound but not many theorists were bold enough to put a number down that they might live to regret, even fewer shared their pristine ideas about what the future held in store, prior to the Big Day.

This is a range of hard-number value estimates I found trawling the internet, there are surprisingly few…there may be more, but if so they were hiding.

Prior to the IPO the average was pulled up by call options, which I guess, if someone is buying, is in a sense an estimate. I don’t imagine anyone is buying options at $60 to $70 now.

So, on average, it looks like the analysts were right, for now at least. That’s obviously a good way to do a valuation, just take the average of the analysts, and BINGO!!

Looking under the bonnet of the valuations, there is an excellent article by Aswath Damodaran in Forbes explaining the difference between “Value” and “Price”, which is about doing a poll to work out the price that everyone thinks is good and then taking a view. That’s basically how the underwriters figure out the price they will go to market at.

Another way of looking at that is the Good-Old-Boy-Wall-Street saying that value is the price you can sell something for to someone dumber than you; which is how they used to value mortgaged backed securities and synthetic collateralized debt obligations like ABACUS in the good-old-days…”mark-to-market”.

Except thanks to the magic of Facebook this time, the poll could determine not just who the dumbest person on Wall-Street is, but instead, who’s the dumbest person in the Whole Universe represented by 900 million friends!!

In that regard, I was explaining the idea of an IPO to my Facebook-addicted daughter and she asked “So how much to buy one share”? When I told her “$38” she said “Cool, I’d pay that!”

So how come so many different opinions….and which approach is “right”?

You would think that by now valuation ought to be easy, they teach it business schools (sort-of) and the world is full of MBA’s who will tell you how to arrive at what International Valuation Standards calls other than market value, and some people call Fair Value. The idea there is that eventually the price will go up, or down to Fair Value, so if it’s above your estimate, you sell; and if it’s below, you buy…do that a few times in a row and you will be as rich as Warren Buffet.

In this instance, the valuation to get “Fair Value” comes down to some sort of income capitalization valuation, you project earnings ten years into the future, apply a discount rate, press the button for NPV on your Excel sheet…and BINGO!! What could be easier than that?

Not many of analysts put up an explanation for how they got to their answer, but out of those who did, the differences in opinion say a lot about where the different valuations came from:

1: The Discount Factor

Everyone who explained what they were doing used a discount factor of 11% to 12% of future earnings so that’s average 11.5% 5% of the average.

2: Earnings

Pre-tax margin as a percentage of revenues ranged from 25% to 35%, i.e. 20% of the average. Aswath Damodaran said 35% like Apple; personally I disagree, for me Facebook’s core business is “Selling-Advertising-On-The-Internet” business, plus, like Google, anything they can pick up from here and there, so that’s where their margins should be headed.

3: Revenues

The big difference was revenues in ten year’s time. Aswath Damodaran who’s “Fair Value” valuation was in the range $20 to $29 pegged revenues at $44 billion in 2022 based on 40% compounded growth for five years followed by a transition down to nominal GDP growth. StarMine said average 10.8% growth over ten-years which gives you $10.5 billion revenues in 2022, which is one-quarter of the number Damodaran was using.

The way I looked at it Facebook will grow following an “S-Curve”, just like Google did until they got a second-wind, and that curve can be predicted pretty accurately from the first years of operation, that ends up at about $11 billion in 2022 except the revenues come quicker earlier on which is why my Fair Value estimate ($11) is higher than StarMine ($9.6).

In that regard, Henry Blodget (Fair Value estimate $16 to $24) pointed out correctly that Facebook is not doing as well as Google did in terms of growing revenues at this point in its development.

I didn’t see much actual market analysis, the point there is that Google already grabbed the low-hanging fruit out of advertizing, and Facebook is Johnny-Come-Lately in that market, and in markets typically the #2 always stays #2. That’s just the Immutable Laws of Marketing….Facebook may have changed a lot of things, but the Immutable Laws are well…immutable.

Then of course there is China story and the story about Facebook’s lookalike, the point is, Facebook is not there, nor is Google which probably explains why the look-alike is doing so well. Nadeem Walayat’s arguments also center round future revenues, he’s pegged Facebook going down to $6 to $8 on the basis that with 900 million users they have saturated the market already.

Where that ends up is that opinions on future revenues range from about $10 billion in ten-years time (or less of you listen to Walayat although he is not specific), up to $44 billion if you listen to Damodaran and perhaps $60 billion of you listen to the likes of Needham who are pegging $40, although they are more waffle than specifics.

So…average say $30 50% that’s the range of uncertainty.

That’s why, if you are doing a valuation, the hardest part, by far, is projecting the revenues in the future. When I do a valuation, I spend 90% of the time thinking about that.

Interestingly I was looking at the program for a course put out for bankers to learn how to do a valuation that arrived un-solicited on my e-mail and was also a banner on some Google sites I visit, less than 5% of the coursework was devoted to working out what markets are going to do in the future.

Do you wonder why there was a credit crunch?

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe. Ex-Toxic-Asset assembly-line worker; lives in Dubai.

© 2012 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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