Summary: A Facebook IPO at $34-48 is overvalued. We can foresee the stock rising to $51 per share if the IPO P/E of 75+ holds and the company can achieve a 30% growth in EPS vs. 2011. To deliver real value the company needs to drive revenue per user up 10X by improving ad effectiveness and click-through.
Facebook has been the biggest business growth story in the last 10 years. The company has captured 50% market share of people with internet access in the world. That is amazing!
But, the company is about to enter a very new chapter through the IPO process. What is next for the company? Can it sustain this growth? Can a free only (not Freemieum like LinkedIn) sustain the business? Can it make large gains in revenue per user? Can it improve advertising effectiveness (Major Advertisers are publicly abandoning the platform)?
The good news is that we’ll all get to watch as the Facebook story unfolds. The answers to each of those questions will be debated by generations of MBAs, consultants, and pundits. I predict a market of Facebook books, Harvard Business School Cases, and TV documentaries will be created. Given the creation of this industry, we at Lime Design felt the need to “pile on.”
Can Facebook Sustain Growth in the user base?
Facebook’s growth in users has been rapidly decelerating over the past 2 years [Data taken from Facebook S1 Filing]. This is typical of markets after they reach the inflection point. For Facebook this occurred in 2008-2009 as you can see from this graph of historical user data. The growth rate of new users was flat in these years and began dropping in 2010.
Facebook has achieved an active user base of 900M – 1B users. This represents 50% of the 2Billion people worldwide that have internet access. The network has become so large that high growth in users is unsustainable. Going forward, Facebook’s growth will be constrained by different factors in different geographies.
- US / Canada / EU – Facebook has reached over 50% of the population and 90% of social media users
- Growth will be based in growth in the overall population
- China – Facebook is currently banned in China
- China is the only real growth possibility for Facebook’s user base provided China lifts the ban on Facebook. Beyond lifting the ban, Facebook would then need to steal Chinese users from other local social media sites. We’ve discounted this in our forward projections.
- Rest of World – Growth in users will be limited to growth in internet
Here is our model for Facebook user growth taking into account the historical data. We are projecting growth in active users to go to 1.3B by 2018. This is still a fantastic growth rate.
Can Facebook increase revenue per user?
Facebook’s growth in Revenue per user peaked in 2008 and has been declining since. Current Revenue per user is approaching $5 per user per year. This amounts to very few users interacting with advertising on the site. Data from Webtrends shows that Facebook click through rates are 1/4 the click through of Google and advertising rates are 1/2 Google (a blog post about advertising effectiveness on Facebook is coming).
In our model, we have predicted that Facebook will close at least part of this gap which will lead to Revenue per user almost doubling by 2018.
The $100Bn Question: Is it a buy on Friday?
- Not on Fundamentals. The anticipated range of $34-$38 puts the stock at a P/E of 75 – 100. This is very difficult to stomach considering most of the growth in users has been exhausted and the growth in revenues per user will be tough.
- Potentially based on hype. But, you would have to stomach a business with poor fundamentals that will likely have significant volatility in the price for the coming years. Our model predicts a projected price of $51 per share assuming the IPO P/E of 75 holds and Facebook achieves the projected growth in EPS of 30%.
What a the keys for Facebook to drive up stock price?
- Using the capital raised through the IPO to:
- Drive a 10X improvement in revenue per user.
- Increasing advertising effectiveness to drive up price per ad
- Increasing user engagement with ads
This drives the stock price to $430 by 2018.