The Facebook IPO scheduled for this week generated a wave of euphoria on Wall Street. But the enthusiasm did not always translate into money carts for investors.
Facebook is listed on the midpoint of the estimated range of $28 to $35 a share, starting with a market capitalization of about $86 billion dollars. That equates to 86 times its earnings for 2011, which was $1 billion. Now, we assume that shareholders want a 10% annual return on their investment. We then project to seven years from now. What will Facebook’s needed earnings and revenues be in order to produce returns?
In our experiment, by the middle of 2019, Facebook should go up 95% the price per share, assuming that there are no dividends paid (something that is common in fast-growing technology companies). It is also reasonable to assume that the network will add at least 1% to the number of shares each year, mainly by issuing stock options to its employees. “A very conservative estimate,” according to Steve O’Byrne of the consulting firm, Shareholder Value Advisors.
Therefore, with 7% of outstanding shares at a price that grows at 95% (i.e. 10% per year), Facebook will reach a market capitalization of 180 billion dollars in 2019.
It is impossible to know what price-earnings multiples Facebook will have in 2019, but we assume it is 20. That range is generous, since it means that investors are expecting more years of above-average growth, even after seven years of frenetic expansion.
Therefore, Facebook would need to gain nearly $9 billion to deliver to investors a decent, if not spectacular, 10% return. That’s a compound annual growth rate of 37%. Only between mid 2018 and mid-2019, Facebook would have to generate additional 2.5 billion dollars in profits. Also, they need to earn 37% for each dollar of earnings to reinvest. That’s three times the average return on equity of large U.S. companies.
Now, we expand our horizon to five years and assume that those 10% returns are still coming. By then, the price-earnings ratio of Facebook should be a little less, say to 18, reflecting its status as a mature giant. Thus, in 2023, the market value of Facebook will be up to another 66% which is needed to settle at 297 billion. Their earnings would amount to 16.5 billion dollars in our hypothetical PER of 18.
For context, the value would exceed the current value of Microsoft. It is worth noting that only nine Fortune 500 companies earned 15 billion dollars or more in 2011.
If Facebook keeps the sales margin of 27% in 2011, its revenue would have to reach 61 billion dollars for the year 2023. In turn, it is expected that the world advertising revenues will grow from 430 billion dollars today to more than 700 billion dollars in 2023. So Facebook would strive to grab something like 8% of all global advertising market in 12 years, stealing market shares from Google and News Corp.