What Value Facebook?

Today some news emerged about Facebook's 2009 financial figures - WSJ:

“According to people familiar with the document, Facebook had net income of $200 million in 2009 on revenue of $777 million. Figures for 2010 weren’t disclosed, but analysts have said the company’s revenue last year could be as much as $2 billion, fueled by advertising growth.”

If it is making up to $2bn today, with reportedly c 550m users (Highest sourceable estimates I have seen), that implies average revenues per user of c $3.60 per annum. Facebook at the end of 2009 had about 275m users, ie about $3 per user per annum. However, these figures will under-estimate actual revenue per user as it is dividing total annual revenues by end of year numbers. Assuming a roughly linear growth allows us to calculate the actual mean running revenue per user was c $4.65 in 2010

Going back to 2008, Facebook ended the year with c 140m users and revenues between $325m (Facebook guidance) and $210m (eMarketer). Splitting the difference gives 2008-9 average revenue per user per annum of about $3.65, in other words Facebook has added a mean $1 per user per annum over 2010.

This allows us to start thinking about "real world" valuations, and comparing it with Goldman Sachs / Facebook's valuation of $50bn.

(1) Revenue ratio-based Valuation

A market cap to revenue ratio of $50bn on $2bn revenues gives a ratio of 25:1. To give an indication, Google is at between 5 and 6:1 today as a mature company, and at its IPO had a ratio of about 13 ($20bn on c $1.5 bn trailing 12 months revenue) and it was growing at a similar rate to Facebook. To believe that Facebook can be a c $50bn company when mature, at the Google ratios, you have to believe it can achieve revenues of about ($50bn/5) = $10bn, ie a 5-fold growth over 2010 revenues.

(2) Margin based Valuation

Assuming that last year's ratios hold true - ie 2009 net income of $200m on $777m revenues, ie c 25%. Translated to 2010 means net income of c $500m on revenues of $2bn*. That gives a price/earning (P/E) ratio of ($50bn/$500m) of c 100:1. Google's P/E ratio today is about 18, and was about 120 at IPO. Assuming Facebook can keep a 25% net income margin, as a mature company, with a Google-ish P/E ratio of c 20 means it needs to generate at least $2.5bn net income, ie revenues of about $10bn per annum - similar to the outcome above.

So it comes to this - to justify its valuation, you have to believe Facebook can achieve c 5-fold growth in about 5 years (after that, NPV is near zero for all practical purposes) at current margins. So where will this growth come from?

- It has a about 550m users, there are about 4bn people online today, of which c 2bn are in the OECD or similar "rich" nations, ie have incomes to support the sort of Ad revenue per user that it's current customer base is worth.

- It has an average revenue per user of c $4.65 per user per annum. Apparently the average user spends about 7 hours a month on Facebook. Assuming most revenue is Ad based, a CPM of c $0.5 (about the norm for the Social Media market) that's about 9,600 Ads that have to be served to each person per annum, or about 800 per month, or about 120 per hour (7 hours/month) or about 2 a minute. (Our preliminary data has Facebook running at about 2 minute per page viewed, so it needs to serve c 4 ads/page)

Looking at how it may get to $10bn revenues:

(i) Assuming average revenue stays the same - Facebook needs a c 5-fold increase in users, ie about 2.75 bn users - or more than 1/3rd of the planet's population, about 2/3rds of the 4bn online, many of those who are earn far less than necessry to justify OECD ARPU.

(ii) Assuming number of users stay constant - Facebook needs a 5-fold increase in revenue per user, is about $23 per user on average per annum. At $0.5 CPM that is 10 ads a minute that each user has to see, or it has to expand to 35 hours a month at the minimum required Ad-rate.

(iii) Assuming a rough doubling of users and revenue per user doubles to c $9.50 - Facebook grows to c 1.1 bn users (a mere 1/6 th of the world's total population) and a rough doubling of revenues per person - e.g Ad rates (2 times more Ads, or 14 hours a month, or $1 CPM).

Throughout I have used CPM as a proxy for the user's mean net present value across al services offered - yes, Facebook may sell virtual tat, or a freemium service, or whatever, but I can't see these being the main revenue drivers in the short to medium term any valuation is based over. In many ways, the fact that Facebook is going through this dodgy private IPO despite revenues of $2bn implies the same. In a way, it's main problem is the stickiness of its pages - too much time reading them, not enoght time clicking through them to get to new Ads. No doubt they are working on this, but unlike Google where you quick-click-to-find, on Facebook you are engaging with the page.

Anyway, that's what you have to believe for a $50bn valuation. My take - its do-able on a wing and a prayer, but the chances of Facebook underperforming is far, far greater than overperforming. Not surprised Goldman's own investment unit passed on it, and Goldmans in facts reserves the right to sell/hedge their stake without warning or notice.....

*Goldman's say first 9 months shows $355m net income on 1.2bn revenues - c30% - but there are likely to be annual costs that are not in that. The New York Times says $400m on $1.2bn - ie c 20% - so we will stick to our 25% estimate for the year for now)