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Posted: 5 June 2012 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

altaltThe mighty 900m-user social mammoth Facebook, after listing at $38, has felt a bit of gravity since. Naysayers have been crowing, but remember that even at $1 per share, the CEO of Facebook has done unusually well for himself.

 

Where do things stand now?

 

At some $64 per user, and $26.90 per share, it appears that the share may be close to the current value of all its future discounted cashflows - as long as:-

 

- It can grow from its current revenue level at 35% annually for the next 7 years.  That implies that it's total revenues will be at the $30bn mark by 2018. Astonishing growth, but remind yourself that Google already brought in $38bn in revenue last year!

 

- Its profitability (pre-tax) can remain at the 35% level. This is a high margin, but also lets the company's cost base shoot up to $19.7bn by that same year - encouraging for workers and suppliers...

 

- Its fixed asset amount on the balance sheet does not exceed 40% of revenue. For a "bright guy and flash-stick" operation like this, that seems easy, but if they will keep paying $bns for the likes of Instagram they may find that about right.

 

- it doesn't need more than the current 5.6% of sales in working capital.

 

- it can persist indefinitely thereafter at 3% growth, servicing its cost of capital,

 

- It finds a clear way of translating the new-fangled accounting which Ernst & Young are developing to try and represent the virtual business initiatives (Farmville etc) into value the wider market can see, believe and want

 

Here is the summary DCF, showing how rapidly the valuation shifts if you shift the growth or margin assumptions.:-

 

alt

 

So am I a buyer yet?

 

Not quite, because

 

- I expect its next numbers will surprise on the upside - I really think the reported taxed profit of 1,000 billion was a manipulated figure, and I think its total labour costs may be reported as lower now thanks to the lower stock price.

 

- I find the financials in the IPO document unconvincing, and certainly while it has a lot of headspace in web advertising (refer Google turnover figure above), I am of the "don't tell me, show me" school. I will watch with interest, though.

 

- I think that the rapid growth of its user base will generate more people wanting to replicate that explosive growth, and some will succeed. It took Facebook 10 months to hit a million signups, and Path.com - a (more sensible?) social app that limits you to 150 friends, hit a million in only 2.5 months. The 150 is a very astute limit - sociologists will tell you that humans have never ever had viable circles of greater than that in terms of real friendship. Acquaintances are different, of course.

 

- I expect that any technical organism which has grown this fast, might just die as fast. I am sure its dollar dimensions will move fast now, but I certainly am unable to construct a scenario of perpetual growth at 3% for this company. Let me know if you can.

 

- I have plenty of choice, with companies I can understand, can see the cash, and can value to current prices using a higher discount rate. And the discount rate is the implied return from your holding, if you get in at the valuation and stay in.

 

Cheers

Stuart

 

 

 


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