Facebook IPO: Price

Update 5/15: Facebook has set its IPO price in the range of $34 – 38. My estimate of $33.75 – 37.87 was about as close as you can get.

In my last post, I covered the date of the Facebook IPO and how you can purchase the stock.  Now comes the important part – what is Facebook worth and what price will the stock trade at?  I will answer both questions because they are equally important. You shouldn\’t decide what to pay for a stock unless you know what it\’s worth and a stock does not always trade at its current value on paper.

This post is categorized as something I call \”theorycrafting\” because that\’s all it really is at this point. Before a stock is publicly traded, you can only hypothesize about what it will trade at because not all factors, such as investor demand, are known yet. Even less is known about a firm as new as Facebook.  If you\’re only interested in the price that I believe Facebook will trade at, feel free to skip to the end of this post.  If you\’re like me and you have a need to understand the logic behind an answer, then please read on.

There are several methods used to price a stock before it trades publicly – comparable firms, company earnings, growth rate multiples and various ratios.  In the case of Facebook, I will be analyzing all of the above.

Earnings

In 2011, Facebook earned $1 billion, while the year before it earned $660 million resulting in a 66% growth rate year over year. That\’s a very solid growth rate, but it is actually declining quarter over quarter.  Another sign of the declining growth rate is Facebook’s operation margin of 50%.  A growth rate this high cannot be maintained and will gradually fall due to the rise of competitors, rising costs, etc.  This means that the earnings growth of Facebook cannot be maintained at its current level unless they reveal something completely unknown at this time to fuel above average growth.  Because of the declining rate, I\’m going to assume a future growth rate of Facebook of 55%; however, this is still optimistic.

Using the 55% growth rate, Facebook would earn $1.55 billion in 2012 ($1B * 1.55) and $2.325B in 2013.  Next, I multiply these projected earnings by the 55x multiple found above → 55 * $1B = $55B, 55 * $1.55B = $85.25B and 55 * $2.325B= $127.55B. Averaging these three numbers results in a valuation of approximately $89 billion.

Revenue

Now, taking a look at revenue, we’ll draw a similar conclusion.  First, let’s take a look at some comparables: Apple, Google and LinkedIn.  Apple is currently trading at 3x its revenue, Google at 5x, and LinkedIn at 15x.  According to revenue, Facebook is growing much faster than Google and Apple, but slower than LinkedIn, so its multiple should of course be lower.  Based on that assumption, Facebook would be valued at 11 – 13 times its revenue, which was $3.7B in 2011  ($3.7B * 13 = $48.1B).  In order to calculate 2012 and 2013, the 55% growth rate is utilized again:

2012 → $3.7B * 1.55 = $5.735B * 13 = $74.55B

2013 → $5.735B * 1.55 = $8.889B * 13 = $115.56B

Averaging the numbers calculated for years 2011 – 2013 gives you a $79.3 billion valuation.

Price per share

Now that we\’ve come up with a rough estimate of what Facebook’s value is, we need to find out what it will be worth per share.  This is the easy part.  According to the most recent numbers, Facebook has about 2.35 billion fully diluted shares.  All we do now is divide the two valuations by the amount of shares.  The earnings valuation comes out to $37.87 per share and the revenue numbers give us $33.75.

Again, as I stated before, it is extremely difficult to price a company that is as new as Facebook.  When determining forecasts and growth rates, the accuracy of your conclusion grows with the amount of data that is calculated.  In this case, I’ve only used the 2011 numbers to forecast what I think the 2012 and 2013 results will be.  Aside from the lack of historical data, simple supply and demand must also be taken into account.  Too much supply and not enough demand will lower the price of any stock while monstrous demand will catapult the

stock price.  As an investor, you have to know that ultimately, something is only worth what others are willing to pay for it.  Because of this fact and the practical certainty that Facebook will be in massive demand, I would add a premium of $10 – $15 when Facebook officially opens and the first trade is executed.

So, at an opening price of $45 – $53, who is going to invest in Facebook on day one?  Who will wait or not purchase the stock at all?