Facebook Valuation - Around $19 a share

I have been doing a few "back of the envelope" calculations on the Facebook IPO. At the moment, details are a bit sparse vis a vis the price of shares and the number of shares to be issued in the IPO. All we really know is that the total value of the shares in the IPO will be US$5,000,000,000 (5 billion).
So how do we value the company based on this info? By making some assumptions.

Note: In this valuation, we will be making some early assumption about the IPO (which may change). So watch these pages in the future as I will update as more info is released to the SEC.

First Assumption - Book Value will be doubled after IPO.
One thing that stands out about the Facebook SEC filing is that the current book value of the company at 31/12/2011 is roughly the same size as the total value of the IPO. (Book Value of company,or net assets = $4,899,000,000)
So I believe that the investment bank assigned to float the company will be looking to double the size of the business. Thus after the IPO, the book value of the Business will be roughly US $10,000,000,000

Second Assumption - Class A and Class B shares will be the same price.
Facebook has gone the two class share structure so Zukerberg can preserve his control over the company. There is no guarantee that the IPO Class A shares will be the same price as the Class B (as Class B has greater weight in voting rights...1 vote of Class B has the same weight as 10 votes of Class A). However for the purposes of this valuation, we will assume they are the same price.

Third Assumption - WACC of Facebook will be 20%
To perform a reasonable valuation of a business, it is important to calculate a businesses WACC or Weighted Average Cost of capital. With a private company, this is quite difficult as WACC depends on the ROE (or return on equity) With Facebook not paying out dividends and with low liquidity due to the restricted secondary market, this ROE is difficult to establish. However, comparing Facebook to Google (WACC of 18.7%) indicates a ROE of 20% may be appropriate. As Facebook has very little debt, we make the next assumption that Facebook's WACC will be the same as it's ROE, which is Google's WACC with a 1.3% risk premium for an unproven public company.

Fourth Assumption - Average Earnings growth of 60% in years 1 and 2 after IPO, 50% in years 3 and 4, 25% growth in 5 and 6. Terminal growth of 4% onwards
According to a paper from Salim Chahine from the Nates School of Management in France, IPO's earnings usually meet only 80% of expectations in the first year after an IPO (See "Long-run abnormal returns after IPO's and optimistic analysts forecasts", International Review of Financial analysis, 2004). Last year, Facebook's earning grew at 65%. 80% of this is approx 52%. So I have assumed that Facebook will grow at an average of 60% over the next two years (as there will be pressure for facebook to perform, I have added a growth premium). I have then added reduced growth of 50% over the following two years and 25% growth the years after that. Terminal growth is the long term growth in perpetuity and I have assumed the 10 year US bond rate for that (plus another 2% premium for a tech company)

With these assumptions in place, we can then use the Residual Income method to calculate the share price. The RI method assumes that value is created when a companies earning
s exceed it's WACC assumed earnings (i.e If a company has a WACC of 20%, earnings of 300 and a Bookvalue of 1000, the RI = 300 - (0.2*1000) = 100. This increase in earnings then gets added to the Book Value of the company which is then used to calculate the next year's RI.

Using this methodology over 6 years (and the terminal year), and discounting the values to the present day using the WACC we get full value for the company (and it's future cash flows) of 38 billion. Divided by the current number of shares indicates a value of $20.40. By dividing the 5,000,000,000 IPO by 20.40, we get an extra 245,125,911 shares added in the IPO.

But this increase in shares will also reduce the value of the shares in our RI valuation. If we divide the 38 billion valuation by the post IPO shareholding (which is 2,121,125,444), we get a valuation of $18.04 a share.

So I would say that the Facebook IPO values would be a issue share price of around $19.00 (average of the two share prices) and around 263,000,000 shares will be issued.

This will put the market capitalisation of Facebook at $40 billion, which is roughly half of the media speculation of $100 billion valuations being bandied about. But this company, with all the hype stripped away, still has an EPS of only 53 cents a share.

Will be interesting to see how close I am once the IPO is released.

Disclaimer: This is a personal opinion based on certain assumptions that may or may not be true. It is not financial advice and should not be taken as a recommendation to invest/not invest in the Facebook IPO.