Facebook, which was founded by Mark Zuckerberg in February 2004, is an online social networking platform with the mission of making the world more open and connected. Within a few years, Facebook attracted millions of new users, from 1 million Monthly Active Users to 845 millions Monthly Active Users. Though competing with global and regional corporations in the industry, Facebook kept growing rapidly. With the high expectation of investors, Facebook finally decided to go public. The “Red Herring” of Facebook stated that its goal was to connect all two billion global Internet users. Basing on our analysis of Facebook’s IPO, we would like to give several recommendations on the investment of Facebook. Analysis
Facebook generated its revenues mainly through advertising. Advertising accounted for 98% of Facebook’s revenue in 2009, 95% in 2010 and 85% in 2011. As a real identity networking website, Facebook can match the proper products based on users’ preferences. Facebook provides advertisers the opportunity to target the users based on the users’ demographic information. It owns any information uploaded by users. Facebook records all these information in database, which can be used by advertisers to target specific segments of users (social context).
Moreover, Facebook generates money by its payments business from selling virtual goods through online gaming companies. Revenues generated from selling goods in online games increased from $13 million in 2009 to $557 million in 2011 and still has upward trend.
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It seems that the huge customer database with tremendous information about these users and the penetration of smartphone are the most significant value drivers of Facebook. As we know, Facebook appealed to people who are looking to reconnect with family and old friends or to find new friends. That is what made Facebook an outstanding company comparing to LinkedIn, Google plus and Twitter etc. In other words, the authentic identity of users together with the strong users base made Facebook an advantageous company. Additionally, the overall technical approaches brought simplicity both in its look and even in its functionality.
In 2011 Facebook Inc. decided to go public because of the rising popularity and the visibility of social media companies. Moreover, Facebook IPO will create public market for the existing shareholders and enable future access to the public equity markets. The Proceeds from the IPO would be used for working capital and other general corporate purposes.
In general, the global economic environment is moving forward now but it is still fragile. The annual GDP growth rate is predicted to be 2.2 percent in 2012, up from 1.7 percent in 2011. Additionally, US unemployment remained high above 8 percent. The market volatility and economic uncertainty had left the IPO market in the doldrums. The number of the IPOs during the first quarter of 2012 fell down significantly to 157 from 383 of the second quarter of 2011. Similarly, raised IPO capital was only 14.3 billion during the first quarter of 2012 compared to 46.6 billion during the first quarter of 2011 (Exhibit 1- 2).
Several Social Networking companies went public in the US in 2011. In May 2011, LinkedIn had raised $353 million by issuing 7.84 million shares at $45/share. Because the demand by investors was overwhelming, the price talk was increased from the range of $32 to $35 to the range of $42 to $45 before IPO day. Although the price already rose sharply before the IPO day, LinkedIn’s stock price rose 109 percent on the first day of trading, making the IPO a huge success.
The Term Paper on Facebook IPO
Facebook, a social networking site, has grown at an exponential rate that far surpasses market expectation, so much so that its growth rate is referred to as the “ Facebook phenomenal”. In 2004, Facebook had 1million monthly active users, and in comparison, it had reached 845million monthly active users in 2011. This phenomenal led to one of the biggest initial public offerings (IPO) the market ...
The “deal-of-the-day” coupon company Groupon went public in November 2011, raising $700 million in the largest US tech IPO since Google. Due to the popularity of the deal, the offered shares were increased from 30 million to 35 million and the price also rose to $20, which is above the initial range of $16 and $18. The share price went up by 43 percent at the first trading day and remained up by 21.3 percent after one week. However, by mid-May it had fallen to $12.17 with a loss of 39 percent post-IPO.
Zynga, the online gaming company, went public in December 2011 and issued 100 million shares at $10/share, which was at the ceiling of the price talk of $8.50 to $10.00. Zynga’s share price fell by 5 percent on the first day of trading and by mid-May was still 14.4 percent below the IPO price.
Intrinsic value refers to the value of a company, stock, currency or product determined through fundamental analysis without reference to its market value. It is ordinarily calculated by summing the discounted future income generated by the asset to obtain the present value. In this case, Facebook’s intrinsic value is its estimate value/share from Discounted Cash Flow analysis.
As it is showed in Exhibit 3, Facebook’s estimated value/share is $32.44 using Discounted Cash Flow analysis. The price from the price talk is $38, which was raised from around $28 to $35 to $34 to $38 per share because of the overwhelming demand from investors. And the price talk is 17% higher than the intrinsic value.
Based on our one-way sensitivity analysis of seven variables as it is showed in Exhibit 4, which are revenue growth rate, terminal growth rate, pre-tax operating margin, increase in Capex, increase in NWC, cost of capital and marginal tax rate, we conclude that cost of capital and pre-tax operating margin are the two most sensitive variables from our calculation of the slope rate R. And our two-way sensitivity analysis is as showed in Exhibit 4.
Despite the fact that Facebook’s IPO will be a significant event in the stock market, there are two concerns about investing in Facebook.
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First, the fact that Facebook is controlled by Marc Zuckerberg, CEO, is concerning. As the biggest Class B shareholder of the company, Mr. Zuckerberg is controlling 56% of the voting rights, guarantying that Mr. Zuckerberg can determine the outcome of the important issues of the company. The major issues include the election of directors, mergers and the sale significant assets. Shareholders will be concerned if they are able to have meaningful input into Facebook’s strategic decisions.
Second concern about investing in Facebook’s stock offering is about the potential of Facebook to deliver above average total returns. With a no-dividend payout strategy, Facebook generates returns from its capital appreciation. Facebook needs to successfully increase its sales and manage its costs to remain competitive and profitable to its investors. Facebook has done a remarkable job of attracting users. With currently an 800 million users base, Facebook has to find a way that can lead to a constant growth of users as well as returns. Otherwise, investors may lose their faith in Facebook, a company that relies on its intangible assets and pays no dividends. However, maintaining a constant growth is a challenging task for any company.
Recommendations:
In our opinion, we recommend that the CXTechnology fund buys Facebook stocks at price within the price talk (34$-38$).
The growing popularity and the visibility of social media companies encourage investing in that field. In comparison with other companies that went public in the same field like Linkedlen, Groupon and Zynga, all these companies achieved price above or equal to the ceiling of the price range. In addition, the estimated cash flows for Facebook (Exhibit 3) are positive and increase over time. Facebook has the potentials to deliver above average total returns. Facebook’s IPO was oversubscribed, which can be viewed as a positive signal for investors. In conclusion, we believe that acquiring Facebook’s stocks at the IPO day is a profitable investment.
