Facebook IPO Essay

Facebook, a mixer benefitworking site, has maturaten at an exponential rate that far surpasses commercialise expectation, so much so that its reaping rate is referred to as the Facebook phenomenal. In 2004, Facebook had 1 one million million million 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 (initial offering) the market had seen in recent years, with total capital raised to be encouraged at $16B, abandoned the $38 per conduct offering price.Facebook was valued at around $96.6B in total. Prior to the initial public offering, the market perceived the rating with arbitrary approval signaled by both Facebooks secret market theatrical role auctions and analysts re ingests. However, as it ordain be examined be funky, Facebook has been signifi goattly over-valued by the underwriters. In addition, the market changed its opinion of Facebook shortly subseque ntly the IPO, criticizing the military rank of the lodge was too high. The differences in market reaction showcase shortfalls in valuation, and it is recommended that analysts and Facebook should have utilize true pickaxe to valuate its market value.Over-valuationThere argon deuce-ace main reasons why Facebook is overvalued at $38 per share.Aggressive Assumptions made by underwritersThe first reason is the $38 per share price is ground on overly offensive assumptions made on Facebooks future tax r flatue enhancement. Facebook generates its taxation in two ship canal display advertisements on its website and adjudge royalties from third-party developers for using Facebooks online payment platform. Out of the two streams of revenue, advertisement accounts for round 82% of the total revenue, and royalty payment only accounts for 18%.Lead underwriter Morgan Stanley, has justified its de boundaryine based on the assumptions that Facebooks revenue bequeath grow moderately considering the increasing popularity of its nomadic app. Morgan Stanley estimated Facebook revenue to grow at 28% CAGR from 2013 2016, with advertising revenue growing at 31% and payment revenue growing at 17% per year. However, it is argu adequate to(p) that these assumptions are overly aggressive, and they leave alone be extremely demanding to realisticize.Upon examining the future prospect of revenue generated from advertising, it can be said that the estimated 31% growth rate cannot be arrive atd. First of all, apt(p) the online advertising market size, and current Facebook market share, Facebook will not be sufficient to achieve the intercommunicate annual growth. In 2011, Facebooks share of the online advertising market is 27% of the $25B diligence. It is projected that the online advertising sector will grow to $45B in 2015, and condition Facebooks current market share, Facebook should be able to generate $12.15B in advertising revenue in 2015. However, this only a ccounts for 20% CAGR.Second, it is uncertain whether Facebook will be able to continue maintain its 27% market share. Facebook disclosed to the public that its current advertisers do not have long-term advertising commitment with Facebook, and many of its advertisers only spend a minuscule proportion of their marketing budget with Facebook. In addition, many companies have started to question the effectiveness Facebook ads. Facebook differentiates its service by emphasizing the premise that ads are to a greater extent effective if a friend recommends it on Facebook compares to traditional online advertising.It can be observed that companies, such as GM, are starting 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. H owever, considering that Facebook is already pricing its ads lower compares to other websites Facebook charges $0.58 per click vis--vis the industry norm of $1, it is hard to argue 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 unlikely that Facebook will achieve the predicated growth rate. Facebook collects royalty payments from developers that use its payment infrastructure to charge players. Currently, Zynga accounts for a substantial portion of the royalty. Considering the intensify competition that Zynga is facing, and its overlook of ability to monetize mobile apps, Zynga will continue to experience sagging growth and will not be able t o contribute a substantial 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 mobile 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 depute for accessing Facebook, Facebook is starting to see a decrease in its revenue, which led to the decrease in its stock prices after the IPO. Overall, the assumptions made by underwriters to justify the $38 per share IPO price are overly aggressive. Estimated just value of common 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 method that Facebook used, one will not reach the $38 per share valuation. Facebook ad opted a mix of Discounted Cash Flow method ( DCFM), Guideline Public Company Method (GPCM), and coddleket Transaction Method (MTM) to determine its profession opening move value and fair value of its private share price prior to the IPO. To achieve the price of $30.89, Facebook assigns a 50% metric slant unit to the MTM, where it considers the volume of transaction of its private shares, the timing of these transactions, the pricing of private shares in the alternate market, and whether the investors involved in the transaction have access to Facebooks financial information.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 cash flow at a discount rate of 15%. The discount rate is conservative, given the risk free rate is at 2.3%, beta for IT services is at 1.06, and the market risk premium of 7%.The assigned weight of t he 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 driven by the hype of the Facebook IPO and the arrogant 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 much 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 historical estimates support the conclusion that Facebook IPO price is over-priced.Comparable Company evaluationThe last reason is based on multiples generated by comparable companies, namely Google and Apple , it can be careful that Facebook valuation is not close to the $96.6B valuation.See Appendix A. Market ReactionsThe market has perceived the IPO with positive remarks. One analyst even valued Facebook to be at $234B compares to the $96.6B IPO valuation. Most analysts either mind Facebook was valued right on the spot or image 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, most analysts jumped on the bandwagon of claiming the underwriters have overvalued the company. Some investors even blamed Mark Zuckerberg for failing 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 dynamic business environment, asymmetry of information, and low level of c orporeal governance.First, the valuation method that most analysts used to valuate Facebook is based on near types of discounted cash flow method. Analysts will look at future growth prospective of the company, and discount the estimated benefit 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 information that would endure one to correctly forecast future earnings and free cash flow, and to assess the strength of company focus and future earning abilities.The model ignores that companies could change their business practices to the dynamic business environment that cannot be decent valuated based on historical data. Facebook does not provide adequate information to allow analysts to generate accepted valuations. It has limited record of its profits, its revenue has been highly volatile, and the business environment it operates i n 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 unheeded 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 challenge relates to valuation is asymmetry of information, which is arguable that it had drove 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 make a better-informed decision of whether to secure Facebook share or not.The asymmetry of information also led to market hype. Investors, without the softer revenue and profit forecasts, construe the market price to be much higher 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 buying 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 buy 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 rationalness 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 compan y 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 improper apocalypse 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 Valuation 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 ever-changing business practices t o meet these volatilities. Real option valuation allows the company to include R&D, brand development, and technology 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, switch uses, outsource or abandon projects.Real options would allow Facebook to valuate its unfermented 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 model by assigning weights to future cash flow given the past 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 given a company, such as Facebook, which does not have a long history 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 rumor facebook inc.. (p. 47). Retrieved from http//sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm.Secondary sourceBerthelsen, C. (2012). Massachusetts hits morgan stanley on facebook ipo. Wall Street daybook , Retrieved from http//online.wsj.com/ phrase/SB ascorbic acid01424127887324407504578185580869680410.html.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.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 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.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 slide nearly 5%. USA Today, Retrieved from http//www.usatoday.com/story/tech/2012/12/17/zynga-apple-app-store-ios-iphone/1775403/.Olanoff, D. (2012, 12 17). Morgan stanley fined $5m over facebook explore and handling 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 one million million million? . Wall Street Journal , Retrieved from http//online.wsj.com/article/SB10001424052702304584404576442950773361780.html.Smith, R. (2012). Hot item Pre-ipo facebook shares. Wall Street Journal , Retrieved from http//online.wsj.com/article/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, 12 17). Morgan stanley fined $5m over facebook research and handlin g 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 detect 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.n yu.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.