Facebook IPO Essay

Facebook, a social ne 2rking site, has grown at an exponential function rate that far surpasses merchandiseplace expectation, so much so that its appendage 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 oblations ( initial public offering) the merchandise had seen in recent years, with total capital brocaded to be valued at $16B, prone everyplace the $38 per voice offering expense.Facebook was valued at around $96.6B in total. Prior to the initial public offering, the mart perceive the valuation with positive approval signaled by both Facebooks buck backstage market deal auctions and analysts reviews. However, as it leave behind be examined below, Facebook has been signifi rumptly over-valued by the underwriters. In addition, the market changed its opinion of Facebook shortly later( prenominal) on the IPO, criticizing the valuation of the beau monde was too high. The differences in market reaction instance shortfalls in valuation, and it is recommended that analysts and Facebook should maintain used accredited option to esteem its market value.Over-valuationThere are common chord main reasons why Facebook is overvalued at $38 per share.Aggressive Assumptions made by underwritersThe first reason is the $38 per share toll is based on overly competitive assumptions made on Facebooks future revenue. Facebook falls its revenue in two ways pompousness advertisements on its website and retain royalties from third-party developers for victimization Facebooks online payment platform. Out of the two streams of revenue, advertisement accounts for about 82% of the total revenue, and royalty payment exactly accounts for 18%.Lead underwriter Morgan Stanley, has justified its price based on the assumptions that Facebooks revenue impart grow moderately considering the increasing popularity of its lively app. Morgan Stanley estimated Facebook revenue to grow at 28% CAGR from 2013 2016, with publicize revenue ripening at 31% and payment revenue ontogeny at 17% per year. However, it is argu adapted that these assumptions are overly vulturous, and they get out be extremely threatening to realize.Upon examining the future prospect of revenue generated from advertising, it can be said that the estimated 31% growth rate can non be getd. First of all, given the online advertising market size, and actual Facebook market share, Facebook will non be able to achieve the projected annual growth. In 2011, Facebooks share of the online advertising market is 27% of the $25B industry. It is projected that the online advertising sector will grow to $45B in 2015, and given Facebooks current market share, Facebook should be able to generate $12.15B in advertising revenue in 2015. However, this only accounts for 20% CAGR.Second, it is chatoyant wheth er Facebook will be able to continue maintain its 27% market share. Facebook disclosed to the public that its current advertisers do not pick out long advertising commitment with Facebook, and many of its advertisers only spend a clarified proportion of their marketing budget with Facebook. In addition, many companies have started to straits the effectuality Facebook ads. Facebook differentiates its service by emphasizing the premise that ads are more(prenominal) effective if a friend recommends it on Facebook compares to traditional online advertising.It can be observed that companies, such as GM, are scratch line to doubt the effectiveness of the so-called social advertising by pulling out their ads on Facebook. This can significantly impact Facebooks share of online marketing in the future. In addition, Facebook disclosed to the public that it might not be able to retain advertisers if it does not reduce its current ad price. However, considering that Facebook is already pr icing its ads lower compares to other websites Facebook charges $0.58 per click vis--vis the industry norm of $1, it is severely to grapple that Facebook will maintain its current revenue level even if it retains 27% of market share as it continues to reduce its ad price. Given the factors mentioned, it can be concluded that the estimated 31% growth rate in advertising revenue is overly aggressive.In addition, Morgan Stanley estimated royalty revenue would grow by 17% however, by looking at the current royalty revenue, it is marvellous that Facebook will achieve the predicated growth rate. Facebook collects royalty payments from developers that use its payment substructure to charge players. Currently, Zynga accounts for a substantial portion of the royalty. Considering the intensified competition that Zynga is facing, and its deprivation of ability to decriminalize unsettled apps, Zynga will continue to experience droopy growth and will not be able to contribute a substant ial amount of royalty to Facebook in the foreseeable future. Thus, it is unlikely that Facebook will achieve 17% growth in its royalty revenue.Lastly, Morgan Stanley made these aggressive assumptions based on the premise that Facebook will be able to monetize its supple app. However, Facebook has not been able to monetize its mobile app to-date. In addition, with the growing number of users using the mobile app as a substitute for assentinging Facebook, Facebook is starting to see a decrease in its revenue, which led to the decrease in its blood prices after the IPO. Overall, the assumptions made by underwriters to justify the $38 per share IPO price are overly aggressive. Estimated fair value of cat valium shares is much lower than $38Facebook has estimated its Class B common stock to be at $30.89 per share as of Jan 31, 2012, and even if one continues with the aggressive estimation mode acting that Facebook used, one will not reach the $38 per share valuation. Facebook adopte d a mix of Discounted Cash Flow order ( DCFM), Guideline Public Company regularity (GPCM), and Market Transaction Method (MTM) to forge its business enterprise value and fair value of its esoteric share price anterior to the IPO. To achieve the price of $30.89, Facebook assigns a 50% weight to the MTM, where it considers the volume of transaction of its clannish shares, the timing of these transactions, the pricing of private shares in the secondary market, and whether the investors involved in the transaction have access to Facebooks fiscal randomness.It then assigns 25% weight to GPCM and DCFM each to determine fair value. GPCM uses multiples of financial ratios in comparable companies in the same industry, and DCFM sums up the net present value of future change time period at a discount rate of 15%. The discount rate is conservative, given the risk fire rate is at 2.3%, beta for IT services is at 1.06, and the market risk premium of 7%.The assigned weight of the method is questionable. Facebook assigns a significant weight to MTM due to the large volume of third-party private stock sales. But considering that the volume transaction and pricing of the private shares were set by the hype of the Facebook IPO and the positive reactions from the market prior to the IPO, it is hard to justify that the MTM valuation represents the true value of Facebook instead of an inflated hyped-up value. It is disputable that Facebook should have assigned less weight to MTM, and more weight to DCFM and GPCM.In addition, it is hard to justify the $7.11 increase of fair market value in a span of 4 months considering that Facebook share only increased by $5.35 in estimated fair market value between 2011 and 2012. The methods discussed above and the diachronic estimates support the conclusion that Facebook IPO price is over-priced.Comparable Company paygradeThe last reason is based on multiples generated by comparable companies, videlicet Google and Apple, it can be calculated that Facebook valuation is not close to the $96.6B valuation. beguile Appendix A. Market ReactionsThe market has perceived the IPO with positive remarks. unmatchable analyst even valued Facebook to be at $234B compares to the $96.6B IPO valuation. some analysts either thought Facebook was valued right on the spot or thought it was undervalued. The hype about the stock was more obvious in the private market. Prior to its IPO, Facebook stocks were trading at a high of $42 compares to its $30 estimated fair market value. In contrast, immediately after the fall, close analysts jumped on the bandwagon of claiming the underwriters have overvalued the beau monde. Some investors even blamed Mark Zuckerberg for impuissance to signal to the investors that the company has been overvalued.The difference in market reaction showcased three shortfalls in valuation. They are objective valuation method that fails to account for impulsive business environment, instability of tuitio n, and low level of corporate arrangement.First, the valuation method that most analysts used to valuate Facebook is based on some types of discounted cash flow method. Analysts will look at future growth likely of the company, and discount the estimated acquire by a discount rate that would be appropriate to capture risks that are foreseeable given the historical financial record. In addition, the traditional discounted cash flow method depends on obtaining learning that would allow one to correctly forecast future earnings and free cash flow, and to assess the strength of company management and future earning abilities.The poseur ignores that companies could change their business practices to the dynamic business environment that cannot be properly valuated based on historical info. Facebook does not provide adequate data to allow analysts to generate reliable valuations. It has limited record of its profits, its revenue has been exceedingly volatile, and the business env ironment it operates in changes frequently. One instance that the underwriters may have overlooked is Facebooks ability to monetize its mobile app as mentioned above. The underwriters may have ignored the importance of substitution of web-accessed Facebook usage by the mobile app accessed usage at the time of the valuation given that this risk was not reflected in historical revenue record.The second repugn relates to valuation is asymmetry of schooling, which is arguable that it had herd up investor expectation that a free lunch scenario will take place. Morgan Stanley was sued and fined for only disclosing softer revenue and profit forecasts to selective investors prior to the IPO and for failing to disclose the cannibalization of Facebook revenue by the increasing popularity of its mobile app adequately to retail investors through the prospectus. Investors with the additional information were able to define a better-informed decision of whether to purchase Facebook share or not.The asymmetry of information also led to market hype. Investors, without the softer revenue and profit forecasts, interpreted the market price to be much high than the private trade price prior to the IPO and the IPO price. This drove the private share price to $42 from $34 on the secondary market. Investors thought by purchasing shares before IPO, they would be able to rip a bigger profit considering that the market price will be higher than $38. Lastly, the asymmetry of information led investors to believe that it will be extremely hard to demoralize Facebook stocks at IPO price given the mentality that the demand for the shares will not meet the supply despite the fact that of Class B shares are locked in to be sold at a later time. The market hype, combined with the surging demand of shares and the lack of investor rationality drove the valuation of the company to be higher than what it really is.The last challenge is the lack of corporate governance. As investors have pointed out, the CEO of the company and the underwriters should have disclosed the information adequately in the prospectus. The lack of corporate governance could be driven by the lack of serious fine for faulty disclosure of information. Morgan Stanley was only fined $5M compares to the $68M underwriting fee it gained from the deal. Also, the lack of governance was driven by hubris and greed. The underwriters stand to gain a bigger underwriting fee for a higher IPO price, and the company stands to gain more capital for higher IPO price. In addition, it is also easier for the underwriter to justify its valuation for a company that cannot be properly valuated based on the traditional discounted cash flow method. The combinations of driver lead to lack of corporate governance in this case.Suggested paygrade MethodIt is suggested that analysts and Facebook should have used real options to valuate the company given the volatility of the business environment Facebook is in, and the ev er-changing business practices to meet these volatilities. concrete option valuation allows the company to include R&D, brand development, and engine room initiatives to be built into its valuation. It is also flexible enough to account for companys ability to change its business practices in the future. Valuation will change in accordance to the options that management will take to delay, expand, contract, smite uses, outsource or abandon projects.Real options would allow Facebook to valuate its rude(a) platforms, new mobile apps, and new technology initiatives to renovate Facebooks current operations. In addition, real option does capture the benefits of discounted cash flow pretense by assigning weights to future cash flow given the early(prenominal) company performance in the market. Given the current Facebook operation model, it is commended that real options should be used to valuate the company.ConclusionIt is extremely hard to valuate a company properly, especially giv en a company, such as Facebook, which does not have a long hi twaddle of stable income nor information that would solidify its future earnings. Market reaction prior to and after the Facebook IPO indicates issues within the current valuation models that companies and analysts are using. It is recommended that companies should start to consider using the real option method to valuate companies with similar business characteristics as Facebook.BibliographyPrimary sourceFacebook. (2012). Registration statement facebook inc.. (p. 47). Retrieved from http//sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm. secondhand sourceBerthelsen, C. (2012). Massachusetts hits morgan stanley on facebook ipo. bulwark Street ledger , Retrieved from http//online.wsj.com/ oblige/SB10001424127887324407504578185580869680410.html.Buley, T. (2009). Facing up to facebooks value. Forbes, Retrieved from http//www.forbes.com/2009/04/06/facebook-advertising-rates-technology-internet-faceboo k.html.Damodaran. (2012). Betas by sector. Retrieved from http//pages.stern.nyu.edu/adamodar/New_Home_Page/datafile/Betas.html.Dunand, E. (2012). Morgan stanley fined $5 million over facebook ipo. Reuters, Retrieved from http//www.cnbc.com/id/100322264.Gustin, S. (2012). Do facebook ads work? . Time Magazine, Retrieved from http//business.time.com/2012/08/07/do-facebook-ads-work/.Joiner, S. (Interviewee), & Ruggeri, C. (Interviewee) (n.d.). Valuation issues in a work through market Mergers and Acquisitions series character reference 1. Audio podcast. Retrieved from http//www.deloitte.com/view/en_LB/lb/centers/cfo-center/3e9619288f709210VgnVCM200000bb42f00aRCRD.htm?theme=cfo.Latimore, D. (2002). calculating value during uncertainty Getting real with real options. Retrieved from http//www-935.ibm.com/services/hk/igs/pdf/g510-3248-calculating-value.pdf.Martin, S. (2012). Zynga shares steal nearly 5%. USA Today, Retrieved from http//www.usatoday.com/story/tech/2012/12/17/zynga-appl e-app-store-ios-iphone/1775403/.Olanoff, D. (2012, 12 17). Morgan stanley fined $5m over facebook research and discussion of ipo by massachusetts. Retrieved fromhttp//techcrunch.com/2012/12/17/morgan-stanley-fined-5m-over-facebook-research-by-massachusetts/.Raice, S. (2012). Is facebook worth $100 billion? . Wall Street Journal , Retrieved from http//online.wsj.com/ phrase/SB10001424052702304584404576442950773361780.html.Smith, R. (2012). Hot item Pre-ipo facebook shares. Wall Street Journal , Retrieved from http//online.wsj.com/ expression/SB10001424052970203833004577249512827646658.html.US Treasury. (2012). daily treasury long term rate data. Retrieved from http//www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=longtermrate. 1 . Facebook. (2012). Registration statement facebook inc.. (p. 47). Retrieved from http//sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm. 2 . ibid. p.1 3 . Ibid. p.13 4 . Olanoff, D. (2012, 1 2 17). Morgan stanley fined $5m over facebook research and handling of ipo by massachusetts. Retrieved from http//techcrunch.com/2012/12/17/morgan-stanley-fined-5m-over-facebook-research-by-massachusetts/. 5 . Ibid. 6 . Raice, S. (2012). Is facebook worth $100 billion? . Wall Street Journal , Retrieved from http//online.wsj.com/article/SB10001424052702304584404576442950773361780.html. 7 . Ibid. 8 . Supra occupation 1 at p.13. 9 . Gustin, S. (2012). Do facebook ads work? . Time Magazine, Retrieved from http//business.time.com/2012/08/07/do-facebook-ads-work/. 10 .Buley, T. (2009). Facing up to facebooks value. Forbes, Retrieved from http//www.forbes.com/2009/04/06/facebook-advertising-rates-technology-internet-facebook.html. 11 . Martin, S. (2012). Zynga shares slide nearly 5%. USA Today, Retrieved from http//www.usatoday.com/story/tech/2012/12/17/zynga-apple-app-store-ios-iphone/1775403/. 12 . Supra Note 1 at p.14. 13 . Supra Note 1 at p.76. 14 . Ibid at p.77. 15 . Ibid. 16 . Damodaran. (2012). Betas by sector. Retrieved from http//pages.stern.nyu.edu/adamodar/New_Home_Page/datafile/Betas.html US Treasury. (2012). Daily treasury long term rate data. Retrieved from http//www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=longtermrate. Re = 2.3%+1.06(7%) = 9.72% Facebook does not have any long term debt. 17 . Supra Note 1 at p.78. 18 . Ibid at p.77 and 78. The estimated fair value of Facebooks shares $25.54 on Mar 31, 2011, and $30.89 on Jan 31, 2012. 19 . Supra Note 6. 20 . Smith, R. (2012). Hot item Pre-ipo facebook shares. Wall Street Journal , Retrieved from http//online.wsj.com/article/SB10001424052970203833004577249512827646658.html. 21 . Joiner, S. (Interviewee), & Ruggeri, C. (Interviewee) (n.d.). Valuation issues in a down market Mergers and Acquisitions series Part 1. Audio podcast. Retrieved from http//www.deloitte.com/view/en_LB/lb/centers/cfo-center/3e9619288f709210VgnVCM200000bb42f00aRCRD.htm?theme= cfo. 22 . Berthelsen, C. (2012). Massachusetts hits morgan stanley on facebook ipo. Wall Street Journal , Retrieved from http//online.wsj.com/article/SB10001424127887324407504578185580869680410.html. 23 . Supra Note 20.