Tag Archives: Facebook

Facebook Seasson 3 – Face/Off

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1000 Days & a bit … As of January 2015 a Facebook share was around Double the price of their initial public offering (IPO) back in May 2012.

That increase in share price & value correspond to an investor belief (conscious or otherwise) that Facebook’s can grab around 40% of the online spend in the (near) Future versus a mediocre 20+% back in 2012.

If you had bought Facebook shares on September 4th 2012 and sold them again December 22nd 2014 (yes just before Christmas) you would have earned 5 times your original investment!

Back in 2012, some month after Facebook’s (FB) IPO, I wrote a Blog Facebook Values … Has the little boy spoken? on the FB value and how to get a feel whether the share price was Naked (“The Ugly”), Half Dressed (“The Bad”) or Nicely Dressed (“The Good”).

I asked whether it was a good time to have confidence and invest in Facebook … My answer (at the time) was that the share price of about 20 US$ (August 2012 timeframe) appeared too low compared with the potential for capturing Online Advertisement Spending Market Share, that furthermore was poised to increase substantially going forward as funds were being redirected from traditional advertisement spend to digital / online media.

The primary source of revenue for Facebook (then & now) is from Online Advertisement Spend. Thus, I looked at what long-term share (chosen arbitrarily to be 5 years) of the Online Ad Market should Facebook have in order to justify its value and share price. Very simply I ramped up the revenue share from its current value to a target share that would correspond to Facebook’s Market Capitalization or Share Price.

In the following I will ignore all the goodies that Facebook have launched or acquired over their lifetime, such as

  • Instagram (Apr 2012).
  • Whatsapp (Feb 2013).
  • Oculus (Mar 2013).
  • Atlas Ad Server Platform (acquisition Feb 2013 & re-vamped Sep 2014).
  • Autoplay Video Ads (Mar 2014).
  • Regular Facebook Software Updates.

(note list is not intended to be exhaustive).

All of the above (and much more) serves to make sure that “People use Facebook to stay connected with friends and family, to discover what’s going on in the world, and to share and express what matters to them”. (i.e., Facebook’s vision statement) … and (I assume) to make maximum profit out of the Facebook “addiction” by providing a very efficient advertisement platform enabled by the gazillion of personal data/information & impressions we all continuously volunteer by using Facebook.

However, while the technologies (e.g., algorithms & communications software utilities) behind are very exiting it all serves one purpose … deliver the most efficient ad to the user and make as much money out of that customer touch point. I believe that the potential and value of Whatsapp is huge and in message volume already exceeds the number daily SMS transactions globally. This still largely remains un-explored by Facebook. The question will be whether FB will primarily use Whatsapp as another Ad delivery vehicle or also as a mean to generate communications revenues in both the messaging and the voice consumer segments.

The conclusion back in August 2012, was that the share price of Facebook, based on its equivalent long-term share of the the Online Ad Market Spend, appeared low and one should expect the price (and value) to increase.

FB share price value & share of online spend

  • Above figure: Analysis presented in my 2012 “Facebook – time to invest?”. Note that the the share price dynamics are illustrated relative to the IPO price of 38 US$ or more accurately the stock price at closing on 18th of May 2012.

So what has happened in the almost 1000 days since the Facebook IPO?

Well after the share price dropped to 17.73 (at closing) on September 4th (2012), which roughly halved the Market Cap of Facebook, the FB Journey has been one of growth.

The cynic might of course point out that so has the rest of the market. However, while for example Nasdaq100 is ca. 68% higher (as of January 20th 2015) compared to the 18-May 2012, Facebook is almost double its IPO value (over the same period). If you take the lowest point (4 Sep 2012) and the highest point (22 Dec 2014) you have a 4.6 times ratio between high & low points.

So if you did the right thing and bought the lowest and sold at the highest … well I told you so (joking!) … Congratulation would be called for!

Here is the FB Journey ( = A Walk on the Wilder Side?) seen from an investors perspective

fb share dynamics

  • Above figure: illustrates Facebook stock price development since the IPO until end of January 2015 with commentary to the peaks and the dips.The Red Dot on September 4th 2012 represents the lowest historical share price (i.e., 17.71 @ closing) and the Green Dot the highest historical share price (i.e., 81.45 @ closing).

Taking the stock price dynamics as shown above, how would the previous analysis come out looking at what Online Ad Revenue Share could justify (approximately) the share price development over the period.

Well … it could look something like this based on Online Advertisement Market Share;

share price & online ad share

  • Above Figure: illustrates the share price dynamics relative to the IPO price, i.e., 100% level (at closing 18 May 2012). Further a relative simple valuation model based on Facebook’s long-term (i.e., 5+ years) online advertisement market share is used to derive the Online Ad Spend share that a given FB share price corresponds to. The methodology has been described in detail in “A walk on the Wild Side”.

Current stock price range is fairly consistent with a 40+% long-term (i.e., 5 year linear ramp up from 2013 share and then keeping the share at the level going forward) share of the Online Advertisement Market. I would expect Facebook to hit at least 10% for 2014 (based on eMarketer data of the total online advertisement market).

Will Facebook be able to grow to 40+% share of the Online Ad Spending?

In my opinion that does not sound completely un-reasonable …

Though it would imply that (a) other social media players also relying on the Online Ad Market are going to lose their livelihood, some (b) business plans might look somewhat more sombre for others and (c)  Facebook needs to take Google Head-On.

It will be very exiting to follow Facebook’s Q4 2014 and Full Year 2014 Earning Call on 28th January 2015 at 2 PM Pacific Time (i.e., 11 PM CET & 1 AM AST 29 January).

I expect to see (28 January 2015); Below find the comparison between my predictions and the real thing (i.e., actual data) out of the Q4 Earnings details as presented at the Q4 & 2014 Full Year Earning Call (28th of January 2015), I also recommend to read the transcript of the earning call on SeekingAlpha Blog. (Strike out text is my predictions prior to Earning Call)

  • Facebook beating Q4 earnings expectations and came out at 3.851B US$ coming out at 3.84B US$ (Low) to 4.16B (US$) (high).
  • MAU 1,393 1,386 Million and Mobile MAU of 1,189 1,182 Million (both lower limit estimates).
  • Share price at closing was slightly higher than previous trading day ending at 76.24 US$ per share (+0.6%) will drop during the day of the earning call to around 71 – 72 US$ per share.
  • Given the already high value of the stock, I do not expect much gain over the days after the earning call. Likely to recover to the level 5 – 10 days before the Q4/Full 2014 Earning Call.

… and I might be completely mistaken (and will be crying all the way to the bank)… but at least we will know within the next hours & days to come!

… So I ended up being fairly close to MAU (0.5% lower), Mobile MAU (0.6% lower) and earnings expectations (0.3% from my lower bound). However, predicting the stock movement … yeah … not so good. Still next couple of days will be interesting to follow. Dave Wehner, Facebook Chief Financial Officer, was where careful in managing expectations for Facebook Topline in 2015. Concerns about exchange rate effects on the Topline could result in a 5% lower revenue than it would have been with 2014 exchange rates. Basically the revenue growth in US$ would reduce somewhat due to exchange rate effects. This is likely to have some negative impact on Facebook profitability and their margin as their fundamental cost base is in US$.

Methodology

See also my Social Media Valuation Blog “A walk on the Wild Side”.

Following has been assumed in FB Valuation Assessment:

  1. WACC 9.11%
  2. 2013 FB capture 6% of total online ad spend.
  3. FB gains a sustainable share of online ad spend X%.
  4. 5 yr linear ramp-up from 2014 9.6% (assessed) to X%, and then maintained at that level.
  5. Other revenues 15% in 2014, linearly reduced to 10% after 5 yrs and then maintained.
  6. Assume FB can maintain a free cash flow yield of 25%.

It should be noted that the above analysis is in all likelihood oversimplifying. However it is not terrible difficult to add complexity. Though given the inherent uncertainties involved in predicting the future, the approach presented is good enough to get an idea about a given investments (or stock purchase) attractiveness.

For the financial history buffs, the Nasdaq100 is ca. 5% from the level of the dot.com foreshock (or pre-crash) of March-2000 and has surpassed the big crash of July-2000.

Acknowledgement

I greatly acknowledge my wife Eva Varadi for her support, patience and understanding during the creative process of creating this Blog.

Appendix

fb & nasdaq100

  • Figure above: shows the share price development from May 18 2012 (IPO date of FB) to 20 January 2015 of Facebook and Nasdaq100 composite. While Facebook largely under-performed in 2012 and well into 2013, its recovery from mid-2013 until January 2015 has been spectacular.

FB daily returns

 

FB vs Nasdaq100

  • Figure above: illustrates Laplace distribution representations of the daily returns of Facebook and Nasdaq100 over the period from 18 May 2012 to 20 January 2015. Note the slight right shift in centre point from the 0%. For a more detailed analysis of the Nasdaq100 and application of the Laplace distribution see the Business Forecasting Blog “The Nasdaq100 Daily Returns and Laplace Distributed Errors”.

online ad spending

  • Figure above: Online Advertisement Spending forecast from eMarketer (August 2013) representing the period 2013 to 2017. From 2018 and to 2022 Forecasts have been extrapolated based on 1st and 2nd derivative of the previous period growth. The resulting trend have been checked against other available projections.

facebook mau vs ad spend region etc

  • Figure above: illustrates for 2013 Facebook Monthly Active Users (MAU) in terms of share of population versus Region (source: Facebook Annual Report 2013), Region’s share of Ad Spend (source: eMarketer), Mobile Internet Penetration (i.e., CDMA2000, UMTS, HSPA, LTE, Mobile WiMax, source: Pyramid Research), and (fixed) internet penetration (i.e., the percentage of population having access to internet).

2017 facebook mau vs ad spend region etc

  • Figure above: illustrates for 2017 Facebook Monthly Active Users (MAU) in terms of share of population versus Region (Source: Authors Facebook Model), Region’s share of Ad Spend (Source: eMarketer), Mobile Internet Penetration (i.e., CDMA2000, UMTS, HSPA, LTE, Mobile WiMax, Source: Pyramid Research), and (fixed) internet penetration (i.e., the percentage of population having access to internet).

2013 mau vs reg lte wifi etc

  • Figure above: illustrates for 2013 Facebook Monthly Active Users (MAU) in terms of share of population versus Region (Source: Facebook Annual Report 2013), LTE penetration (Source: Pyramid Research), WiFi residential potential estimated from the broadband household penetration (Source: Pyramid Research), and  Mobile Internet Penetration (i.e., CDMA2000, UMTS, HSPA, LTE, Mobile WiMax, Source: Pyramid Research). For Facebook’s Autoplay Video feature it is important for the user to either have WiFi access or for a decent cellular performance LTE.

2017 mau vs reg lte wifi etc

  • Figure above: illustrates for 2017 Facebook Monthly Active Users (MAU) in terms of share of population versus Region (Source:Source: Authors Facebook Model), LTE penetration (Source: Pyramid Research), WiFi residential potential estimated from the broadband household penetration (Source: Pyramid Research), and  Mobile Internet Penetration (i.e., CDMA2000, UMTS, HSPA, LTE, Mobile WiMax, Source: Pyramid Research). For Facebook’s Autoplay Video feature it is important for the user to either have WiFi access or for a decent cellular performance LTE.

Facebook Values … Has the little boy spoken?

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Facebook has lost ca. 450+ Million US$ per day since its IPO … or about 40 Billion US$ … in a little under 90 days (i.e., reference date 17-08-2012).

This is like loosing an Economy such as the Seychelles every second day. Or a Bulgaria  in less than 90 days. (Note: this is not to say that you could buy Bulgaria for $40B … well who knows? 😉 … the comparison just serves at making the loss of Facebook value more tangible. Further one should not take the suggestion of a relationship between market value of a corporation such as Facebook with GDP of country too serious as also pointed out by Dean Bubley @disruptivedean).

That’s a lot of value lost in a very short time. I am sure Bulgarians,”Seychellians” and FB investors can agree to that.

40 Billion US Dollar?  … Its a little less than 20 Mars Missions … or

40 Billion US Dollar could keep 35 thousand Americans in work for 50 years each!

So has the little boy spoken? Is the Emperor of Social Media Naked?

Illustration: THORARINN LEIFSSON http://www.totil.com

Let’s have a more detailed look at Facebook’s share price development since May 18th 2012.

The Chart below shows the Facebook’s share price journey, the associated book value, the corresponding sustainable share of Online Ad Spend (with an assumed 5yr linear ramp-up from today’s share) and the projected share of Online Ad Spend in 2012.

In the wisdom of looking backwards …  is Facebook, the Super-Mario of Social Media, really such a bad investment? or is this just a bump in a long an prosperous road ahead?

I guess it all rise and fall with what ever belief an investor have of Facebook’s ability to capture sufficient Online Advertisement Spend. Online Ad spend obviously includes the Holy Grail of Mobile Ad Revenues as well.

FB’s revenue share of Online Ad Spend has raised steady from 1.3% in 2009 to ca. 5% in2011 and projected to be at least 6% in 2012.

Take a look at FB’s valuation (or book value) which at the time of the IPO (i.e., May 18th 2012) was ca. 80+ Billion US Dollars. Equivalent to a share price of $38.32 per share (at closing).

In terms of sustainable business such a valuation could be justifiable if FB could capture and sustain at least 23% of the Online Ad Spend in the longer run. Compare this with ca. 5% in 2011. Compare this with Googles 40+% om 2011. AOL, which is Top 5 of best companies at conquering Online Advertisement Spend, share of Online Ad Spend was a factor 15 less than Google. Furthermore, Top-5 accounts for more than 70% of the Online Ad Spend in 2011. The remaining 30% of Online Ad Spend arises mainly from Asia Pacific logo-graphic, politically complicated, and Cyrillic dominated countries of which Latin-based Social Media & Search in general perform poorly in (i.e., when it comes to capturing Online Ad Spend).

Don’t worry! Facebook is in the Top 5 list of companies getting a piece of the Online Advertisement pie.

It would appear likely that Facebook should be able to continue to increase its share of Online Ad Spend from today’s fairly low level. The above chart shows FB’s current share price level (closing 17-August-2012) corresponds to a book value of ca. $40 Billion and a sustainable share of the Online Ad Spend of a bit more than 10+%.

It would be sad if Facebook should not be able to ever get more than 10% of the Online Ad Spend.

From this perspective:

A Facebook share price below $20 does seem awfully cheap!

Is it time to invest in Facebook? … at the moment it looks like The New Black is bashing Social Media!

So the share price of Facebook might drop further … as current investors try too off-load their shares (at least the ones that did not buy at and immediately after the IPO).

Facebook has 900+ Million (and approaching a Billion) users. More than 500+ Million of those 900+ Million Facebook users are active daily and massively using their Smartphones to keep updated with Friends and Fiends. In 2011 there where more than 215 Billion FB events.

Facebook should be a power house for Earned and Owned Social Media Ads (sorry this is really still Online Advertisement despite the Social Media tag) … we consumers are much more susceptible to friend’s endorsements or our favorite brands (for that matter) than the mass fabricated plain old online  advertisement that most of us are blind to anyway (or get annoyed by which from awareness is not necessarily un-intended ).

All in all

Maybe the Little Boy will not speak up as the Emperor is far from naked!

METHODOLOGY

See my Social Media Valuation Blog “A walk on the Wild Side”.

Following has been assumed in FB Valuation Assessment:

  1. WACC 9.4%
  2. 2012 FB capture 6% of total online ad spend.
  3. FB gains a sustainable share of online ad spend X%.
  4. 5 yr linear ramp-up from 2012 6% to X%, and then maintained.
  5. Other revenues 15% in 2012, linearly reduced to 10% after 5 yrs and then maintained.
  6. Assume FB can maintain a free cash flow yield of 25%.

Social Media Valuation …. a walk on the wild side.

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Lately I have wondered about Social Media Companies and their Financial Valuations. Is it hot air in a balloon that can blow up any day? Or are the hundred of millions and billions of US Dollars tied to Social Media Valuations reasonable and sustainable in the longer run? Last question is particular important as more than 70% of the value in Social Media are 5 or many more years out in the Future.  Social Media startup companies, without any turnover, are regularly being  bought for, or able to raise money at a value, in the hundreds of millions US dollar range. Lately, Instagram was bought by Facebook for 1 Billion US Dollar. Facebook itself valued at a $100B at its IPO. Now several month after their initial public offering, Facebook may have lost as much as 50% of the originally claimed IPO value.

The Value of Facebook, since its IPO,  has lost ca. 500 Million US Dollar per day (as off 30-July-2012).

What is the valuation make-up of Social Media? And more interestingly what are the conditions that need to be met to justify $100B or $50B for Facebook, $8B for Twitter, $3B (as of 30-July-2012, $5B prior to Q2 Financials) or $1B for Instagram, a 2 year old company with a cool mobile phone Photo App? Is the Social Media Business Models Real? or based on an almost religious belief that someday in the future it will Return On Investment. Justifying the amount of money pumped into it?

My curiosity and analytical “hackaton” got sparked by the following Tweet:

Indeed! what could possible justify paying 1 Billion US Dollar for Instagram, which agreeably has a very cool FREE Smartphone Photo App (far better than Facebook’s own), BUT without any income?

  • Instagram, initially an iOS App, claims 50 Million Mobile Users (ca. 5 Million unique visitors and 31 Million page-views as of July 2012). 5+M photos are uploaded daily with a total of 1+ Billion photos uploaded. No reported revenues to date. Prior to being bought by Facebook for $1 Billion, was supposed to have been prepared for a new founding round valued at 500 Million US$.
  • Facebook has 900M users, 526M (58%) active daily and 500M mobile users (May 2012). 250M photos are uploaded daily with a total of 150 Billion photos. Facebook generated ca. $5B in revenue in 2011 and current market cap is ca. $61B (24 July 2012). 85% of FB revenue in 2011 came from advertisement.

The transaction gives a whole new meaning to “A picture is worth a Billion words”  … and Instagram is ALL about PICTURES & SOCIAL interactions!

Instagram is a (really cool & simple) mobile & smartphone optimized App. Something that would be difficult to say about FB’s mobile environment (in particular when it comes to photo experience).

One thing is of course clear. If FB is willing to lay down $1B for Instagram, their valuation should be a good deal higher than $1B (i.e., ca. $4+B?). It will be very interesting to see how FB plans to monetize Instagram. Though the acquisition might be seen as longer-outlook protective move to secure Facebook’s share of the Mobile Market, which for Social Media will become much more important than the traditional desktop access.

So how can we get a reality check on a given valuation?

Lets first look at the main Business Models of today (i.e., how the money will be or are made);

  1. Capture advertising spend – typically online advertisement spend (total of $94B in 2012 out of an expected total Media Ad spend of $530B). With uptake of tablets traditional “printed media” advertising spend might be up for grabs as well (i.e., getting a higher share of the total Media Ad spend).
  2. Virtual Goods & credits (e.g., Zynga’s games and FB’s revenue share model) – The Virtual Economy has been projected to be ca. $3B in 2012 (cumulative annual growth rate of 35% from 2010).
  3. Payed subscriptions (e.g., LinkedIn’s Premium Accounts: Business Plus, Job Seeker, etc or like Spotify Premium, etc..).
  4. B2B Services (e.g.,. LinkedIn’s Hiring Solutions).

The Online Advertisement Spend is currently the single biggest source of revenue for the Social Media Business Model. For example Google (which is more internet search than Social Media) takes almost 50% of the total available online advertisement spend and it accounts for more than 95% of Google’s revenues. In contrast, Facebook in 2011 only captured ca. 4+% of Online Ad Spend which accounted for ca. 85% of FB’s total revenue. By 2015 eMarketeer.com (see http://www.emarketer.com/PressRelease.aspx?R=1008479) has projected the total online advertisement spend could be in the order of $132B (+65% increase compared to 2011). USA and Western Europe is expected to account for 67% of the $132B by 2015.

Virtual Goods are expected to turn-over ca. $3B in 2012. The revenue potential from Social Networks and Mobile has been projected (see Lazard Capital’s Atul Bagga ppt on “Emerging Trends in Games-as-a-Service”) to be ca. $10B worldwide by 2015. If (and that is a very big if) the trend would continue the 2020 potential would be in the order of $60B (though I would expect this to be a maximum and very optimistic upside potential).

So how can a pedestrian get an idea about Social Media valuation? How can one get a reality check on these Billionaires being created en mass at the moment in the Social Media sphere?

“Just for fun” (and before I get really “serious”) I decided see whether there is any correlation between a given valuation and the number of Unique Visitors (per month) and Pageviews (per month) … my possible oversimplified logic would be that if the main part of the Social Media business model is to get a share of the Online Advertisement Spending there needs to be some sort of dependency on the those (i..e, obviously whats really important is the clickthrough (rate) but lets be forget this for a moment or two):

 The two charts (log-log scaled) shows Valuation (in Billion US$) versus Unique Visitors (in Millions) and Pageviews (in Billions). While the correlations are not perfect, they are really not that crazy either. I should stress that the correlations are power-law correlations NOT LINEAR, i.e., Valuation increases with power of unique and active users/visitors.

An interesting out-lier is Pinterest. Let’s just agree that this does per see mean that Pinterest’s valuation at $1.5B is too low! … it could also imply that the rest are somewhat on the high side! 😉

Note: Unique Visitors and Pageview statistics can be taken from Google’s DoubleClick Ad Planner. It is a wonderful source of domain attractiveness, usage and user information.

Companies considered in Charts: Google, Facebook, Yahoo, LinkedIN, Twitter, Groupon, Zynga, AOL, Pinterest, Instagram (@ $1B), Evernote, Tumblr, Foursquare, Baidu.

That’s all fine … but we can (and should) do better than that!

eMarketeer.com has given us a Online Advertisement Spend forecast (at least until 2015). In 2011, the Google’s share amounted to 95% of their revenue and for Facebook at least 85%. So we are pretty close to having an idea of the Topline (or revenue) potential going forward. In addition, we also need to understand how that Revenue translates into Free Cash Flow (FCF) which will be the basis for my simple valuation analysis. To get to a Free Cash Flow picture we could develop a detailed P&L model for the company of interests. Certainly an interesting exercise but would require “Millions” of educated guesses and assumptions for a business that we don’t really know.

Modelling a company’s P&L is not really a peaceful walk for our interested pedestrian to take.

A little research using Google Finance, Yahoo Finance or for example Ycharts.com (nope! I am not being sponsored;-) will in general reveal a typical cash yield (i.e., amount of FCF to Revenue) for a given type of company in a given business cycle.

Examples of FCF performance relative to Revenues: Google for example has had an average FCF yield of 30% over the last 4 years, Yahoo’s 4 year average was 12% (between 2003 and 2007 Google and Yahoo had farily similar yields ).  Facebook has been increasing its yield steadily from 2009 (ca. 16%) to 2011 (ca. 25%), while Zynga had 45% in 2010 and then down to 13% in 2011.

So having an impression of the revenue potential (i.e., from eMarketeer) and an idea of best practice free cash flow yield, we can start getting an idea of the Value of a given company. It should of course be clear that we can also turn this Simple Analysis around and ask what should the Revenue & Yield be in order to justify a given valuation. This would give a reality check on a given valuation as the Revenue should be in reasonable relation to market and business expectations.

Lets start with Google (for the moment totally ignoring Motorola;-):

Nothing fancy! I am basically assuming Google can keep their share of Online Advertising Spend (as taken from eMarketeer) and that Google can keep their FCF Yield at a 30% level. The discount rate (or WACC) of 9% currently seems to be a fair benchmark (http://www.wikiwealth.com/wacc-analysis:goog). I am (trying) to be conservative and assumes a 0% future growth rate (i.e., changing will in general have a high impact on the Terminal Value). If all this comes true, Google’s value would be around 190 Billion US Dollars. Today (26 July 2012) Google Finance tells me that their Market Capitalization is $198B (see http://www.google.com/finance?q=NASDAQ:GOOG) which is 3% higher than the very simple model above.

How does the valuation picture look for Facebook (pre-Zynga results as of yesterday 25 July 2012):

First thought is HALLELUJAH … Facebook is really worth 100 Billion US Dollars! … ca. $46.7 per share… JAIN (as they would say in Germany) … meaning YESNO!

  • Only if Facebook can grow from capturing ca. 6% of the Online Advertisement Spend today to 20% in the next 5 – 6 years.
  • Only if Facebook can improve their Free Cash Flow Yield from today’s ca. 25% to 30%.
  • Only if Facebooks other revenues (i.e., from Virtual Goods, Zynga, etc..) can grow to be 20% of their business.

What could possible go wrong?

  • Facebook fatigue … users leaving FB to something else (lets be honest! FB has become a very complex user interface and “sort of sucks” on the mobile platforms. I guess one reason for Instagram acquisition).
  • Disruptive competitors/trends (which FB cannot keep buying up before they get serious) … just matter of time. I expect this to happen first in the Mobile Segment and then spread to desktop/laptop.
  • Non-advertisement revenues (e.g., from Virtual Goods, Zynga, etc..) disappoints.
  • Need increasing investments in infrastructure to support customer and usage growth (i.e., negative impact on cash yields).
  • The Social Media business being much more volatile than current hype would allow us to assume.

So how would a possible more realistic case look like for Facebook?

Here I assume that Facebook will grow to take 15% (versus 20% above) of the Online Ad spend. Facebook can keep a 25% FCF Yield (versus growing to 30% in the above model). The contribution from Other Revenues has been brought down to a more realistic level of the Virtual Goods and Social Media Gaming expectations (see for example Atul Bagga, Lazard Capital Markets, analysis http://twvideo01.ubm-).

The more conservative assumptions (though with 32% annual revenue growth hardly a very dark outlook) results in a valuation of $56 Billion (i.e., a share price of ca. $26). A little bit more than half the previous (much) more optimistic outlook for Facebook. Not bad at all of course … but maybe not what you want to see if you paid a premium for the Facebook share? Facebook’s current market capitalization (26 July 2012, 18:43 CET) is ca. $60B (i..e, $28/share).

So what is Facebooks value? $100B (maybe not), $50+B? or around $60+B? Well it all depends on how shareholders believe Facebook’s business to evolve over the next 5 – 10 (and beyond) years. If you are in for the long run it would be better to be conservative and keep the lower valuation in mind rather than the $100B upside.

Very few of us actually sit down and do a little estimation ourselves (we follow others = in a certain sense we are financial lemmings). With a little bit of Google Search (yes there is a reason why they are so valuable;-) and a couple of lines of Excel (or pen and paper) it is possible to get an educated idea about a certain valuation range and see whether the price you paid was fair or not.

Lets just make a little detour!

Compare Facebook’s current market capitalization of ca. $60B (@ 26 July 2012, 18:43 CET) at $3.7B Revenue (2011) and ca. $1B of free cash flow (2011). Clearly all value is in anticipation of future business! Compare this with Deutsche Telecom AG with a market capitalization of ca. $50B at $59B (2011, down -6% YoY2010) and ca. $7.8B of free cash flow (2011). It is Fascinating that a business with well defined business model, paying customers, healthy revenue (16xFB) and cash flow (8xFB) can be worth a lot less than a company that relies solely on anticipation of a great future.  Facebook’s / Social Media Business Model future appear a lot more optimistic (the blissfull unknown) than the Traditional Telco Business model (the “known” unknown). Social Media by 2015 is a game of maybe a couple of hundred Billions (mainly from advertisement, app sales and virtual economy) versus the Telecom Mobile (ignoring the fixed side) of a Trillion + (1,000 x Billion) business.

Getting back to Social Media and Instragram!

So coming back to Instagram … is it worth paying $1B for?

Let’s remind ourselves that Instagram is a Mobile Social Media Photo sharing platform (or Application) serving Apple iOS (originally exclusively so) and Android. Instagram has ca. 50+M registered users (by Q1’2012) with 5+M photos uploaded per day with a total of 1+B photos uploaded. The Instagram is a through-rough optimized smartphone application. There are currently more than 460+ photo  apps with 60Photos being a second to Instagram in monthly usage (http://www.socialbakers.com/facebook-applications/category/70-photo).

Anyway, to get an idea about Instagram’s valuation potential, it would appear reasonable to assume that their Business Model would target the Mobile Advertisement Spend (which is a sub-set of Online Ad Spend). To get somewhere with our simple valuation framework I assume:

  1. that Instagram can capture up to 10% of the Mobile Adv Spend by 2015 – 2016 (possible Facebook boost effect, better payment deals. Keep ad revenue with Facebook).
  2. Instagram’s  a revenue share dynamics similar to Facebooks initial revenue growth from Online Ad Spend (possible Facebook boost effect, better payment deals. Keep ad revenue with Facebook).
  3. Instagram could manage a FCF Yield to 15% over the period analysed (there could be substantial synergies with Facebook capital expenditures).

In principle the answer to that question above is YES paying $1B for Instagram would be worth it as we get almost $5B from our small and simple valuation exercise … if one believes;

  1. Instagram can capture 10% of the Mobile Advertisement Spend (over the next 5 – 6 years).
  2. Instagram can manage a Free Cash Flow Yield of at least 15% by Year 6.

Interesting looking at the next 5 years would indicate a value in the order of $500M. This is close to the rumored funding round that was in preparation before Facebook laid down $1B. However and not surprising most of the value for Instagram comes from the beyond 5 years. The Terminal Value amounts to 90% of the Enterprise Value.

For Facebook to breakeven on their investment, Instagram would need to capture no more than 3% of the Mobile Ad Spend over the 5 year period (assuming that the FCF Yield remain at 10% and not improving due to scale).

Irrespective;

Most of the Value of Social Media is in the Expectations of the Future.

70+% of Social Media Valuation relies on the Business Model remaining valid beyond the first 5 years.

With this in mind and knowing that we the next 5 years will see a massive move from desktop dominated Social Media to Mobile dominated Social Media, should make us somewhat nervous about desktop originated Social Media Businesses and whether these can and will make the transformation.

The question we should ask is:

Tomorrow, will today’s dot-socials be yesterday’s busted dot-coms?

PS

For the pedestrian that want to get deeper into the mud of valuation methodologies I can really recommend “Valuation: Measuring & Managing the Value of Companies” by Tim Koller, Marc Goedhart & David Wessels (http://www.amazon.com/Valuation-Measuring-Managing-Companies-Edition/dp/0470424656). Further there are some really cool modelling exercises to be done on the advertisement spend projections and the drivers behind as well as a deeper understand (i.e., modeling) of the capital requirements and structure of Social Media Business Models.

In case of interest in the simple models used here and the various sources … don’t be a stranger … get in touch!

PSPS (as of 28-July-2012) – A note on Estimated Facebook Market Capitalization

In the above Facebook valuation commentary I have used the information from Google Finance (http://www.google.com/finance?q=facebook) and Yahoo Finance (http://finance.yahoo.com/q?s=FB) both basing their Market Capitalization estimation on 2.14B Shares. MarketWatch (http://www.marketwatch.com/investing/stock/fb) appear to use 2.75B shares (i.e., 29% high than Google & Yahoo). Obviously, MarketWatch market capitalization thus are higher than what Google & Yahoo would estimate.