Goldman Sachs’ recent $500 million investment in Facebook that values the entire business at fifty billion dollars raises the question, can a business that was founded in college dormitory seven years ago really be worth that sort of money?
It is possible Facebook is worth that sort of money, but to figure out if it really is, we have to crunch some numbers. So here is a back of an envelope calculation.
Learning from others
The first thing we need to look at is similar examples, the closest comparison is Google who were launched on the stockmarket shortly after Facebook were founded and today have a market worth of $195 billion.
So Facebook’s investors are valuing the business at about ¼ of Google’s size. Yahoo’s stock analysis of Google allows us to look at the rough numbers.
Income
Currently, Google is earning 29.3 Billion and making a profit of 8.5billion for a Price to Equity (P/E) of 23.26.
To justify a 50 billion dollar valuation on similar rations, Facebook would have to make around 2 billions dollars profit on revenues of $8 billion .
Facebook is reported to have made $1.2 billion in sales with $355 millon profit in the first nine months of 2010. If we extrapolate that, crudely assuming no revenue growth in the last 3 months, we come to 2020 earnings of $1.6 billion and roughly $450 million profit.
So Facebook has to grow revenues and profit by a factor of five, based on the same ratios as Google, to achieve the $50bn valuation. Where could this come from?
Advertising revenue
The bulk of Facebook’s current revenue comes from advertising, according to Inside Facebook in 2009 all but $10million of their $660 million earnings came from one form of advertising or another.
Online advertising is going to continue to grow spectacularly, a 2010 Morgan Stanley research paper illustrated (on slide 25 of the previous link) how advertisers will have to increase spending onling by $50 billion to match the Internet’s share of media consumption.
It’s a fair assumption that Facebook, as the biggest social medial platform, will get a large slice of that $50 billion. If Facebook were to capture 10% of the market’s growth, they’d achieve their valuation easily.
We should also consider that most of Facebook’s revenue is coming from the United States and they barely touched international markets, so there’s even more potential growth in their advertising revenue.
Games revenue
One of Facebook’s biggest growth opportunities comes from the games. Games like Farmville and Mafia Wars are proving popular with the user base; Zynga, the developer of Farmville, itself has a projected market capitalisation of $5.8 billion.
The global games business is valued at $105 billion dollars and much of this market is moving to web based, online platforms. Should Facebook based games grab 10% of that market, the platform’s 30% cut would see another 3 billion go into Facebook’s revenue, most of which would be profit.
The credits market
Related to the games market is the sale of credits for purchases of games and other features like virtual, and real, gifts and products.
It’s almost impossible to quantify what that market would be but already credits have gone on sale in US stores like WalMart and Best Buy and the virtual world site Habbo Hotel reports 2010 credit revenues of 4.5 million Euros on a user base that is a fraction of Facebook’s size.
So is Facebook worth $50 Billion?
Facebook’s fifty billion dollar valuation is feasible. That’s not to say there aren’t risks, it’s possible Facebook could turn out to be another fad like Myspace or that users might decide to value their privacy over Facebook’s benefits.
While it’s not an investment you’d like to see your grandmother in as a safe source of retirement income, for risk tolerant Russian fund managers and high income clients of Goldman Sachs, it’s a punt worth taking.
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