Sorry Bears, Facebook Is Worth More Than $15

Over the weekend, Barron's published a weekend cover story loudly proclaiming, "Facebook (NASDAQ: FB  ) is worth $15." I'm no Facebook bull, mind you, but I still think that Facebook is worth much more than $15. After all, it is a recent and active Motley Fool Rule Breakers recommendation for a reason.

Let's dig into the bearish argument to see if it holds any weight.

Where'd that figure come from?
First off, that $15 valuation appears to be an arbitrary figure that was pulled out of thin air. The article asks, "What are the shares worth?" It then answers, "Perhaps only $15." Perhaps. That doesn't sound like a discounted cash flow model or comparable valuation analysis. It sounds like author Andrew Bary wanted a round number and $15 had a nice ring to it.

He does point out that a $15 share price translates into 24 times next year's earnings and six times next year's sales, not cheap by most accounts. The article then compares those valuation metrics to heavyweights Apple (NASDAQ: AAPL  ) and Google (NASDAQ: GOOGL  ) , both of which it says trade near 16 times 2012 earnings.

What's the point?
While the temptation to compare Facebook to Apple and Google is obvious, since all three are household names and among the most influential companies throughout the tech sector, such a comparison is somewhat specious because the maturities of their respective businesses are dramatically different.

Company

Market Cap

Revenue (TTM)

Net Income (TTM)

P/E (TTM)

P/S (TTM)

Apple

$647.9 billion

$148.8 billion

$40.1 billion

16.4

4.4

Google

$244.3 billion

$43.2 billion

$11.1 billion

21.6

5.6

Facebook

$46.1 billion

$4.3 billion

$577 million

147.1

13.1

Source: Morningstar. TTM = trailing 12 months.

Facebook is a much younger business, and its financials are but a small fraction of what the iPhone maker or search giant can boast, so stacking them up next to each other in valuation isn't particularly useful. Smaller growth companies with a lot of major potential in the coming years typically do trade at premiums relative to their older, more mature peers.

A more apt comparison would be to compare Facebook up against professional networker LinkedIn (NYSE: LNKD  ) , a more direct competitor in the same social media space that is closer in the maturity of its business. LinkedIn trades at 1,050 times earnings and 18 times sales, making Facebook look downright cheap. Despite being smaller, with a $13 billion market cap, LinkedIn boasts superior monetization of its user database.

No one wants to be like Zynga
One of the more viable concerns is Facebook's heavy use of stock-based compensation. The social network is known for doling out equity to employees, which doesn't do any favors for its GAAP results but tends to benefit the non-GAAP figures that the Street likes to follow. Facebook's first public earnings release included $1.3 billion in share-based compensation and related payroll tax expenses, primarily as a result of the frothy IPO.

If Facebook shares continue downward, the company could run into a problem with employee retention, much like its partner Zynga (NASDAQ: ZNGA  ) is seeing amid a cratering stock price and massive executive exodus.

Show me the money
One of the biggest uncertainties in Facebook's future remains mobile monetization. This is absolutely unproved at this point and a huge risk facing the social network, but it's also one of the most promising opportunities Facebook has ahead of it. Mark Zuckerberg's recent appearance at TechCrunch Disrupt showed investors that he's a capable leader with a distinct vision of Facebook's mobile future -- enough to send shares higher by 8% the day after his pep talk.

Facebook's network effects are unstoppable at this point, with monthly active users, or MAUs, set to cross the billion-user threshold any day now. Even before factoring in MAU growth, Facebook could see plenty of revenue upside simply by more effective monetization of its existing user base. Average revenue per user, or ARPU, in other geographies, still lags significantly relative to its domestic digits.

Geographical Segment

Ad ARPU (MRQ)

Payments ARPU (MRQ)

MAUs

US & Canada

$2.60

$0.60

186 million

Europe

$1.21

$0.21

246 million

Asia

$0.47

$0.08

255 million

Rest of World

$0.41

$0.04

268 million

Sources: SEC filings and author's calculations. MRQ = most recent quarter.

For example, if Facebook was hypothetically able to achieve ad monetization levels internationally that were just half of its domestic performance, then we would be talking about nearly an additional $500 million in revenue -- about 40% more than it actually posted. That's before we even consider payments upside or MAU growth.

Sounds easy
That's easier said than done, but the key there is focusing on content localization, such as switching to local currencies in payments, or building up employee headcounts locally that are more familiar with local culture. Zuckerberg made it clear that Facebook is now a "mobile company," and while that path to transition has clear road hazards, it also has some very massive bottom-line potential.

Another risk that's again eerily reminiscent of Zynga is that Facebook may be embarking down a questionable acquisition strategy. The $1 billion acquisition of Instagram, the no-revenue social photo sharing service, comes to mind. That's much more than the $180 million that Zynga paid for OMGPOP, an admitted disappointment. Hopefully, Instagram won't be Facebook's OMGPOP.

$15? Sold!
Facebook certainly carries a lofty valuation, and while I may not be interested in investing at current prices, the company continues to progress towards a balancing point of monetization and valuation that's legitimately piquing my interest.

You can argue that Facebook may be somewhat overvalued right now, but at $15 -- 27% lower than even today's low, after Barron's sparked a selloff -- I think it would be undervalued. Heck, if it ever gets down there, I may just even buy shares myself.


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