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Why Facebook May Really Be Worth $50 Billion

2011 January 4

It was recently announced that Facebook received a $500 million investment from Goldman Sachs that puts the total value of the company at $50 Billion.  Wow!  Congratulations Mark Zuckerberg!

However, a valuation that high begs the question:  Is it really worth that much?  I admit, I was skeptical at first, but having run some numbers, it appears decidedly less ridiculous than I first thought.  In actuality, the price reflects some fairly reasonable assumptions.

How to Value a Company

Valuing a company is a subjective process.  What might be worth a lot to me might not be worth so much to you.  We could have different ideas about what the future will bring or I might already own something that would make such a great fit that both assets together could be worth far more than the sum of the parts.

Whatever the methodology, there is only one reason to buy a company:  You have to believe that buying it will earn you more with less risk than putting the money somewhere else.

Here are some ways of figuring that out:

Discounted Earnings: This is the most common way to value a company.  After all, what is an investment if not a stream of future earnings?  US Treasury Bills are considered risk free, so they give very little income.  Corporate bonds give you a fixed income every year, but there’s always a chance that they will default, so returns are higher for corporate debt.

Stocks, however, are riskier than bonds.  There is no rate of return specified and, if things go poorly, you lose everything while the bondholders at least get paid something.  Therefore, investors expect a better return from equity investments.  The S&P 500 has delivered about 9% returns over the long term, with a lot of ups and downs.

Discounting earnings, however, is complicated and subjective.  You have to not only project earnings, but also make a judgement about what interest rate you will employ to discount them.  Therefore, Price to Earnings (P/E) ratios are often used as useful shortcuts and PEG ratios take into account growth as well. Looking at both, you can get a basic idea of value.

Revenues: Of course, sometimes discounting earnings and P/E ratios aren’t viable because either the company is a start up without significant profits or it has fallen on hard times.  In those cases, Price to Sales ratios make more sense when comparing to similar companies.

Alternative Methods: While some method of discounting earnings or comparing companies by turnover are standard, there are a variety of other methods.  For instance, Enterprise Value estimates what a company might be worth to an acquirer.  Cable and Telecom companies have sometimes been valued on the basis of subscriber base, etc.

There are, of course, other things to consider.  For instance a company whose management is highly regarded will be worth more than a similar company that doesn’t instill confidence.  Some industries get a lot of attention and that will also drive perceptions of value.

Nevertheless, no matter what method you use, you will want to compare the company to others that run similar businesses.

Media Comparisons

Probably the best place to start getting an idea what Facebook might be worth is to look at mature media company valuations.  I’ve analyzed a handful in the table below:

The first thing that should catch your eye is that $50 billion is a lot of money to pay for a media company.  It’s almost as much as Disney and more than News Corp or Time Warner.  These are big, well managed companies that have a consistent profit history.

Furthermore, media companies aren’t cheap. The P/E ratios of most companies in the chart exceed the S&P average (around 15 and 13 for trailing and forward P/E’s. respectively).

Of course, we have no idea what Facebook earns, but it has been reported that their revenues for the past year were around $2 billion, which would indicate a price/sales ratio of a whopping 25! (Compared to between 1 and 2 for most media companies)

When comparing to mature media companies on the basis of any metric, valuing Facebook at $50 billion looks very aggressive

Google and Apple Comparisons

Of course, Facebook is very different than a mature media company.  It is very young and growing super fast.  Therefore, we also want to look look at other high-flying tech companies like Google and Apple.

When measured against these companies, $50 billion for Facebook starts looking considerably less crazy.  First of all, it represents only one quarter the value of Google and one sixth the value of Apple.  Facebook’s price/sales ratio of 25 is still much higher, but it is growing at exponential rates (if reports are to believed, 100% last year).

Another important point of difference is that these companies have much higher profit margins than the mature media companies, which means they earn more on less revenues.  It’s fairly safe to assume that Facebook’s margins are also high, or will become so.

Finally, it must be said, that the market caps of Google and Apple aren’t excessive by any means.  Their forward P/E ratios are similar to that of mature media companies.  The combination of strong top line growth and meaty profit margins makes these companies relatively cheap, despite their high valuations.

How To Get to $50 Billion

To be honest, there’s no way to be sure what Facebook is worth.  Only time will tell us that.  However, the important question to answer is whether we can believe that it is worth that much without making any wacky predictions.

In order to answer that particular question, I used the following assumptions:

  • Facebook 2010 revenues: $2 billion (from unsubstantiated reports)
  • Facebook revenue growth: 100% (also from reports)
  • Benchmark ROI: 9% (historical S&P average, including dividends)
  • Facebook PE in 5 years: 25 (the same as Google)
  • Facebook profit margin in 5 years: 20% (Between Google and mature media companies; same as Apple)

Now, if we assume investors would be happy with anything over 9% return on their investment, Facebook would have to be worth a bit more than $70 billion in five years.  Using a P/E of 25 and 20% profit margins, that would imply earnings of 2.8 billion and revenues of $14 billion.  Even compared to mature media companies, those do not seem excessively high.

Moreover, to achieve these numbers, Facebook would only have to grow their revenues at an average compound rate of about 50% per year. That’s a lot, but well under their current rate, if reports are to be believed.  That doesn’t mean it’s a lock, but it’s certainly doable.

So while $50 billion for a company that was launched in 2004 might seem outrageous at first glance, in reality it is not unrealistic.  The bigger question, of course, is where it will go from here.  There remain many open questions about where the revenue growth will come from.

One thing is for sure, this is going to be fun to watch!

- Greg

Update: Recent reports put Facebook’s margins at 30%-40%, which makes the valuation even more tenable.

23 Responses leave one →
  1. January 4, 2011

    The 25x P/E isn’t that far out of the ball park these days. Check out the figures from these clothing companies:

    http://seekingalpha.com/article/42783-lululemon-makes-other-hot-clothing-ipos-look-cheap

    All of them are around 25x too. Lululemon, the focus of that post, has subsequently come back to be valued at around 25x times too, which seems fairly amazing for a company selling yoga pants…
    Tim Kastelle´s last blog post ..End of Year Innovation Questions

    [Reply]

    Greg Reply:

    Tim,

    Yes, those are also high valuations. However, Facebook’s valuation is 25x sales, not earnings. Which is quite another matter.

    Like I said in the post, with their top line growth rates, it’s not out of the question, but still far above the clothing retailer multiples in the article.

    - Greg

    [Reply]

  2. January 5, 2011

    Hi Greg,

    Interesting analysis just as with the others that I listened to and read about because the question that came to mind for many of us out there was how was it valued at $50 billion and whether it wasn’t optimistically over-valued as with other similar social media communication companies including those that have faded away during the dotcom days?

    I still have doubts and reservations but perfectly understand the basis as explained and the fact that Facebook has been the fastest growing internet/tech business and many organisations have tapped into it for advertising and brand exposure/marketing which in itself is indirect sales & increases the sales value.

    Good luck to the founders and staff of Facebook and hope it all goes well and lasts long as well! By the way, I am not a user but understand the tremendous opportunity it has brought to many to keep in contact with family and friends and also for use by businesses to increase their reach.

    [Reply]

    Greg Reply:

    Marion,

    I still have my doubts as well, but you can make the numbers work. The problem is, when assume 50% growth over 5 years there is an enormous amount of room for error. It will be interesting to see what actually happens.

    Thanks a lot for coming by and commenting.
    - Greg

    [Reply]

  3. January 6, 2011

    Investing in Facebook at this stage is definitely a speculative bet on Facebook’s management’s ability to come up with new revenue streams. Benjamin Graham certainly wouldn’t invest in a company with 25 Price/Sales.

    Until now Facebook’s revenue growth has mainly been fueled by user growth and that should peak soon, after all there’s a limited number of people on this planet.

    But Facebook has many many opportunities like a true Google Adsense competitor (imagine Facebook’s granular targeting options brought to any site in the world) that could generate the kind of profits needed to beat the 9% benchmark.

    At the end of the day it’s a very risky investment (look at how quickly Myspace went down) and there’s plenty of other opportunities with similar potential rewards where you don’t have to be a Goldman Sachs High Net Worth Investor and that have a better fit with your personal values (think Greentech).
    Silvester´s last blog post ..rucx- RT @atul- NYTimescom- Friends With Benefits http-melt-4C0oH GS

    [Reply]

    Greg Reply:

    Silvester,

    I would be inclined to agree with you. It is highly speculative. As I wrote to Marion, when you’re assuming CAGR of 50%, there is a lot of room for error. And that’s just to get a fairly normal return.

    I’m not so sure revenue growth is due to audience growth. Again, only Facebook knows for sure, but it seems to me that their revenue has doubled over the past year while audience has only grown 10% or 20%.

    Building an Ad sense competitor would be a great idea. Another thing they could do is skip the ad sense and allow advertisers to access their data for targeting, which might be even better.

    Thanks for a great comment!

    - Greg

    [Reply]

  4. Pranav permalink
    January 6, 2011

    Greg,

    Nice article

    While considering the 50% growth rate and the ad-sense competitor, the other thg to wonder is this addiction going to last? it has lasted for now..what abt future? human interest is short and till the time they dont keep on inoovating, the interests might fall. They have been doing good at it, with apps like farmville, poker, etc.

    Monetization is the key here. If they can come up with a model of people able to use cash/card to buy points and use those points across the internet universe like on amazon, ebay, etc or you know encash rewards that is going to be a sure short winner!

    Cheers
    Pranav

    [Reply]

    Greg Reply:

    Pranav,

    You’re absolutely right. Monetization is the key.

    One point about 50% growth, that’s CAGR across 5 years, and the earlier years have way more impact. So, if they are grow at close to a hundred in the first year, it becomes fairly easy to achieve even if the rate falls to 20% in the last year.

    - Greg

    [Reply]

    Pranav Kapoor Reply:

    Another thought is how much is every user worth!

    So assuming a $50B evaluation, and 500MM users every user is valued at $100

    On the other hand, $2B of revenues and 500M users so every user is payg right now $20….

    Now, the question is would I contribute $20 (in fees, transactions, ad revs, etc) if FB gives me all those apps?

    I dont think thats a big no. at all…

    [Reply]

    Greg Reply:

    Pranav,

    That’s another way of looking at it:-)

    However, I think their plan is to leverage their network over a bigger part of the web than just the FB site.

    - Greg

  5. January 7, 2011

    Thanks for the interesting analysis, Greg. I was also asking myself why FB should be valuated that high.

    [Reply]

    Greg Reply:

    Thanks, Stan. Good to see you again.

    - Greg

    [Reply]

  6. Tim Bradburn permalink
    January 11, 2011

    Hi Greg

    Very illuminating post – thanks for running the figures!

    I was once at a talk by Tom Farmer, the Scottish entrepreneur who founded Kwik-Fit in a garage and then sold it to Ford for over a billion dollars.

    I asked him how he had arrived at that figure, expecting the kind of technical explanation you’ve just given here. Instead he just replied “because that’s what I wanted for it” :-D

    It sometimes amazes me how even huge decisions can be based on plain old human instinct!

    By the way, have you seen Social Network? If the film is to be believed, Facebook started with a pairing between a maverick and a business head, which on paper seems like a good mix of personality types. But Facebook only went meteoric after the maverick ditched the business head and paired up with someone even more maverick!

    A simplistic way of looking at it, I know, but it did make me ask myself some deeper questions about the personality mix in teams.

    Wishing you a great 2011.

    Best regards

    Tim

    [Reply]

    Greg Reply:

    Tim,

    You make a good point. Something is worth whatever someone is willing to pay for it. As I mentioned in the post, value is highly subjective.

    However, the point that I wanted to make is that a $50 billion valuation is not irrational. I found (much to my surprise) that the numbers actually do work.

    - Greg

    [Reply]

  7. Vladimir permalink
    February 13, 2011

    Thank you very much!
    Very interesting research.
    P.S. Just after the movie I asked myself the same questions ))

    [Reply]

    Greg Reply:

    Спасибо!

    - Greg

    [Reply]

  8. George Paul permalink
    August 1, 2011

    I have to say that valuing a new company, especially an infant social-networking company is a mystically subjective exercise. It fall under the realm of soothsayers and oracles.

    One thing is definitely true. It is going to be REAL fun observing the market footprint of FB in the coming years. Do I smell an impending bubble, or do I see another Google in the making…. ??? How do I know…. I ain’t a soothsayer. Nor are the so called ‘gurus’ at Goldman Sachs. So why don’t we all take a ringside seat and watch the fun as it unfolds in the future…. And You I-banking Stiffo’s… Why don’t u grab a seat as well… coz, I’m darn sure that, in reality, you guys are as clueless as anyone else.

    [Reply]

    Greg Reply:

    Thanks for your input. We’ll see how it goes.

    - Greg

    [Reply]

  9. Harshit permalink
    February 9, 2012

    Greg, thank you for such a detailed study of Facebook’s valuation. The only thing I couldn’t understand in your post is what calculations you made to arrive at $70Bn figure in “if we assume investors would be happy with anything over 9% return on their investment, Facebook would have to be worth a bit more than $70 billion in five years”

    Would be great if you can explain this in a bit detail.

    Cheers,

    Harshit

    [Reply]

    Greg Reply:

    $50 billion today earning 9% returns would be $70 billion in 5 years.

    I should mention as well that Facebook’s actual numbers turned out quite a bit stronger than I assumed in this post.

    - Greg

    [Reply]

    Harshit Reply:

    Thanks Greg. Yes, actual profit comes to abt 27%. It will be interesting to see what numbers facebook clocks when it lists on the stock exchange.

    [Reply]

  10. March 1, 2012

    Hello,

    How did you get a P/E ratio of 25? Did you divide FB’s market value of $50billion by its Revenues of $2? If you did, you didn’t really do it correctly as you should divide the $50 billion by FB’s earned billings which were under $1 billion. This would get a P/E of 50 which makes this a different story.

    [Reply]

    Greg Reply:

    Luchik,

    No. As I wrote, I just assumed that in five years the PE ratio would be similar to Google’s (which would indicate $50 Billion today if discounted at 9%).

    Greg

    [Reply]

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