Price of Facebook's Shares in the Moment of IPO - Essay Example

Facebook IPO Executive summary Facebook Inc. is among the most famous and successful companies of the last years. Personal story of its founder and owner is used as an example of American business dream. Business model of the company and its way is an example for the other companies, not only from IT industry, but from other business areas. Facebook went IPO last spring. The initial valuations of the company’s values were $80 billion. However, the price was almost immediately pushed down and still remains at about half of its initial value. Many experts believe that the initial price of $38 was too high. The main task of this paper was to calculate the so-called fair price of the company’s shares in the moment of IPO. Two different approaches are going to be used to reach the goal of the task – DCF and comparative valuation. Taking into account this goal, the paper has the following structure: introduction (brief background information about the company), theoretical concepts and methodology, financial analysis, conclusions. Introduction (brief background information about the company) As it has been already mentioned, Facebook Inc. is one of the most successful companies in the modern business world. It is among the leaders not only in the IT industry, but in the global business environment, in general. The company was founded in 2004 as a website for the local Harvard community. The company has become successful quite soon. Nowadays it employs almost 2000 employees, has offices in the different countries around the whole world, and has almost 1 billion of users. Its current market capitalization is $56.8 billion. Some additional information about the company under consideration can be got from the following quote. “Facebook, Inc. operates as a social networking company worldwide. The company builds tools that enable users to connect, share, discover, and communicate with each other; enables developers to build social applications on Facebook or to integrate their Websites with Facebook; and offers products that enable advertisers and marketers to engage with its users. As of February 2, 2012, it had 845 million monthly users and 443 million daily users. The company was founded in 2004 and is headquartered in Menlo Park, California” (Facebook Inc. Company Profile). Probably the biggest question is what the factors of the company’s success are. The company has provided for people around the world an opportunity to communicate without any barriers. We believe that it is the main driver of the company’s success. Communication is among the greatest need of people and Facebook provides such an opportunity. Once again it has made the world more united and single. The most interesting thing is that there is still a great potential for growth for the company, since a lot of people do not use its services. Theoretical concepts and methodology As we have already mentioned the main task of this research paper is to define the fair price of the company under consideration in the moment of IPO. That is why some theoretical definitions and concepts should be provided. It is time to say a few words about methodology that is going to be used in the paper. There are a lot of methods to calculate a fair price of a company’s stock. Two of them will be used in this research paper: discounted cash flow (DCF) and peer (comparative valuation) methods. A formal definition of the DCF method may be the following. “DCF method is a valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one” (DCF Definition).  Thus, DCF method reflects the essence of fair price of a company’s stock – reflection of the range of future cash flows from a company’s performance. This method is more difficult for calculations, but it reflects a company’s fair price more precisely. The second method is based on the principle that a company should have the same market capitalization as the similar companies. That is why financial indicators of these companies are compared and then a fair price is calculated. The most difficult task in this case is to choose the right peers. Financial analysis First of all, we are going to calculate the company’s fair price, using comparative valuation method. The following companies have been chosen for the analysis: Amazon.com Inc., AOL Inc., Apple Inc., Cisco Systems Inc., Ebay Inc., Electronic Arts, Google Inc., Linkedin Inc., Microsoft Corp., Yahoo Inc., Zynga Inc., Renren Inc., and Intuit Inc. The following step will be to choose financial ratios that will be used for comparative valuation. We have chosen the following ratios: Price/Book Value, Enterprise value (EV)/EBITDA and P/E ratios. Probably, the most difficult financial ratio for consideration is enterprise value. The data for all the mentioned companies, needed for further calculations, is provided in the table below.   Price Market capitalization Debt Cash and equivalent EBITDA Preferred shares Net income APPLE INC 584,78 550000000000,00 0 29129 58518 0 41733 MICROSOFT CORP 27,08 227920000000,00 10713 63040 30714 0 16978 ELECTRONIC ARTS INC 14,74 4500000000,00 1078 1849 286 0 76 CISCO SYSTEMS INC 18,96 100660000000,00 16297 48716 12291 0 8041 INTUIT INC 58,2 17230000000,00 499 744 1439 0 792 YAHOO INC 18,93 22390000000,00 0 2055,579 1473 0 1048,827 AMAZON.COM INC 243,4 110250000000,00 1415 9576 2016 0 631 EBAY INC 51,15 6619000000,00 1525,047 5929,402 3371,023 0 3229,387 GOOGLE INC 670,71 220390000000,00 2986 44626 14079 0 9737 FACEBOOK INC 26,15 56650000000,00 398 3908 2079 615 1000 AOL INC 36,58 3060000000,00 66,2 407,5 357 0 13,1 LINKEDIN CORP 107,59 11560000000,00 0 577,504 68,945 0 11,912 RENREN INC -ADR 3,39 1280000000,00 0 1040,716 -19,201 0 41,256 ZYNGA INC 2,35 1840000000,00 0 1811,354 -310,047 0 -404,316 This information has been got from the companies’ official financial statements and other available sources. We can use this information to calculate indicators for the ratios that will be used for comparative valuation. Thus, these indicators are provided in the table below. Price Market capitalization EBITDA Book value EV Net income APPLE INC 584,78 550000000000,00 58518000000 21175000000 549999970871,00 41733000000 MICROSOFT CORP 27,08 227920000000,00 30714000000 4175000000 227919947673,00 16978000000 ELECTRONIC ARTS INC 14,74 4500000000,00 286000000 215000000 4499999229,00 76000000 CISCO SYSTEMS INC 18,96 100660000000,00 12291000000 859000000 100659967581,00 8041000000 INTUIT INC 58,2 17230000000,00 1439000000 157000000 17229999755,00 792000000 YAHOO INC 18,93 22390000000,00 1473000000 166595000 22389997944,42 1048827000 AMAZON.COM INC 243,4 110250000000,00 2016000000 11145000 110249991839,00 631000000 EBAY INC 51,15 6619000000,00 33710230 4250000 6618995595,65 3229387000 GOOGLE INC 670,71 220390000000,00 14079000000 588000000 220389958360,00 9737000000 FACEBOOK INC 26,15 56650000000,00 2079000000 63000000 56649995875,00 1000000000 AOL INC 36,58 3060000000,00 357000000 74900000 3059999658,70 13100000 LINKEDIN CORP 107,59 11560000000,00 68945000 28217000 11559999422,50 11912000 RENREN INC -ADR 3,39 1280000000,00 -19201000 20381000 1279998959,28 41256000 ZYNGA INC 2,35 1840000000,00 -310047000 44020000 1839998188,65 -404316000 Now we are able to calculate the indicators for the further peer valuation. These indicators are provided in the following table.   P/E P/B EV/EBITDA APPLE INC. 13,18 25,97 9,40 MICROSOFT CORP 13,42 54,59 7,42 ELECTRONIC ARTS INC 59,21 20,93 15,73 CISCO SYSTEMS INC 12,52 117,18 8,19 INTUIT INC 21,76 109,75 11,97 YAHOO INC 21,35 134,40 15,20 AMAZON.COM INC 174,72 9,89 54,69 EBAY INC 2,05 1,56 196,35 GOOGLE INC 22,63 374,81 15,65 FACEBOOK INC 56,65 899,21 27,25 AOL INC 233,59 40,85 8,57 LINKEDIN CORP 970,45 409,68 167,67 RENREN INC -ADR 31,03 62,80 -66,66 ZYNGA INC -4,55 41,80 -5,93 It is important to apply a fair share for each indicator in a final valuation. Our indicators are going to have the following shares: P/E – 40%, P/B – 30%, EV/EBITDA – 30%. The following step is to calculate average indicators. P/E P/B EV/EBITDA 116,29 164,53 33,25 The final step is to calculate the value of the company’s shares according to these average indicators and their shares. After all the needed calculations we can say that the fair market capitalization of the company should be $70.362 billion. Taking into account the number of the company’s shares we can say that the price should have been $32.48. It is a bit lower than the initial price in the moment of IPO. It means that the underwriter made a mistake, but this mistake was not very high. A fair price of the company should be about $33. The current price is a bit more than $26. Therefore, we can say that market underestimate the company and its potential. We believe that it may be related to the current condition of the market and consequences of the global financial crisis. However, the final conclusion can be only made after DCF valuation. The most important things in DCF valuation is to choose the right period for analysis and calculated the discount rate. The discount rate is equal to weighted average cost of capital. The period for analysis is nine years. The forecasted cash flows are based on the average annual cash flows for the previous 5 years. Also, we have paid attention to the company’s official financial statements and forecasts. According to our calculations, the price of the company’s share should be approximately $38. Once again we must that the company’s shares are underestimated on the market. However, we must admit that underwriter was right choosing the target price for the company. On the other hand, these calculations are actual now. The price was different in the moment of IPO. All the calculations are provided in the attachment. Conclusions To conclude we would like to say the following. We should admit that the company’s undertaker made a mistake and overestimated the company’s shares. However, the mistake was not significant. A fair price is still higher than the current price. We tend to relate it to the state of the market and consequences of the global financial crisis. Works cited Comparative Valuation Definition. 27 Nov. 2012, DCF Definition. 27 Nov. 2012, Enterprise Value Definition. 27 Nov. 2012, Facebook Inc. Company Profile. 27 Nov. 2012, Read More