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Saving faith

8 May 2012 By Richard Beales

Facebook founder Mark Zuckerberg appears a bit sheepish about touting the company’s initial public offering. He probably doesn’t need to be. The hype around the social network makes it likely the price will go above the indicated $28-to-$35 a share range, which values the company at up to $96 billion. But an update of Breakingviews’ discounted cashflow calculator for Facebook shows that sanity is still at the low end of the valuation scale.

The price range revealed last week was actually a ratcheting down of the loftiest expectations. Facebook stock recently changed hands on secondary markets at an implied valuation north of $100 billion, and that may not have included the more than $5 billion of new cash the company plans to raise.

Breakingviews’ analysis in March projected Facebook’s revenue and margins based loosely on Google’s history and then applied a DCF method to arrive at a valuation. Big assumptions are needed – including that Zuckerberg’s company will expand as fast and profitably as the internet search giant did seven years earlier, when its top-line growth already appears to be slowing – but this is still among the most rational approaches available. Excluding new money from the IPO, the result was a valuation of around $75 billion.

Updated for the expected IPO proceeds, the latest share count information and the cash on Facebook’s balance sheet, the DCF valuation goes up to about $83 billion, or just above $30 a share. Well over half of that value depends on cash flows coming after 2021. With that risk in mind, any investor expecting some instant potential upside in the form of an IPO discount would be disappointed at a price of much more than $28 a share.

The valuation is, however, highly sensitive to the chosen inputs. Facebook’s 33-strong phalanx of underwriting banks probably won’t struggle to sell Zuckerberg’s grander, fuzzier and potentially more valuable vision of a world glued together by his social network – even if the 27-year-old doesn’t show up to every roadshow stop in person. That could easily push the price up again even before the IPO. For old-fashioned number-crunchers, though, reality tops out near the bottom of the range the company just suggested.

A new Breakingviews e-book chronicling Facebook’s rise shows why its business model, corporate governance and exuberant valuation shouldn’t make it a love story.

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