Quis Pendit Ipsa Pretia: Facebook Valuation and Diagnostic of a Bubble Based on Nonlinear Demographic Dynamics

Posted: 21 May 2019

See all articles by Peter Cauwels

Peter Cauwels

ETH Zurich; Director Quaerens CommV

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

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Date Written: December 31, 2011

Abstract

We present a novel methodology to determine the fundamental value of firms in the social-networking sector, motivated by recent realized IPOs and by reports that suggest sky-high valuations of firms such as Facebook, Groupon, LinkedIn Corp., Pandora Media Inc, Twitter, Zynga. Our valuation of these firms is based on two ingredients: (i) revenues and profits of a social-networking firm are inherently linked to its user basis through a direct channel that has no equivalent in other sectors; (ii) the growth of the number of users can be calibrated with standard logistic growth models and allows for reliable extrapolations of the size of the business at long time horizons. We illustrate the methodology with a detailed analysis of Facebook, one of the biggest of the social-media giants. There is a clear signature of a change of regime that occurred in 2010 on the growth of the number of users, from a pure exponential behavior (a paradigm for unlimited growth) to a logistic function with asymptotic plateau (a paradigm for growth in competition). We consider three different scenarios, a base case, a high growth and an extreme growth scenario. Using a discount factor of 5%, a profit margin of 29% and 3.5 USD of revenues per user per year yields a value of Facebook of 15.3 billion USD in the base case scenario, 20.2 billion USD in the high growth scenario and 32.9 billion USD in the extreme growth scenario. According to our methodology, this would imply that Facebook would need to increase its profit per user before the IPO by a factor of 3 to 6 in the base case scenario, 2.5 to 5 in the high growth scenario and 1.5 to 3 in the extreme growth scenario in order to meet the current, widespread, high expectations. To prove the wider applicability of our methodology, the analysis is repeated on Groupon, the well-known deal-of-the-day website which is expected to go public in November 2011. The results are in line with the Facebook analysis. Customer growth will plateau. By not taking this fundamental property of the growth process into consideration, estimates of its IPO are wildly overpriced.

Keywords: Facebook, social-networking, valuation, IPO, S-curve, logistic growth, forecast, fundamental value, bubble

JEL Classification: D46, G12, G32

Suggested Citation

Cauwels, Peter and Sornette, Didier, Quis Pendit Ipsa Pretia: Facebook Valuation and Diagnostic of a Bubble Based on Nonlinear Demographic Dynamics (December 31, 2011). Journal of Portfolio Management, Vol. 38, No. 2, 2012. Available at SSRN: https://ssrn.com/abstract=2191556 or http://dx.doi.org/10.2139/ssrn.2191556

Peter Cauwels (Contact Author)

ETH Zurich

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Director Quaerens CommV ( email )

Bruges
Belgium

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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