Econophysicists Peter Cauwels and Didier Sornette at the Swiss Federal Institute of Technology in Zurich recently released a study that claims that Facebook's valuation has been overblown.
In the report, the econophysicists claim to have devised a novel way to determine the true value of the big social media giants, such as Facebook, Groupon, LinkedIn, Pandora, Twitter, and Zynga. Turning their gaze toward Facebook, their findings put a damper on the massive $65-$100 billion IPO the world is expecting.
Ultimately, it’s just a numbers game.
Cauwels and Sornette claim that there’s only one true metric to be concerned with: the number of users on Facebook. With 750 million users (notwithstanding a few million dead ones), the scientists turned a keen eye on the revenue that so many users would naturally generate, as well as Facebook's potential for ongoing growth.
Cauwels and Sornette came up with three different growth 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 of revenues per user per year yields a value of Facebook of $15.3 billion in the base case scenario, $20.2 billion in the high growth scenario and $32.9 billion in the extreme growth scenario," they explained in the report.
Therefore, Cauwels and Sornette‘s calculations are based on the prospect of each user generating $1 profit per year, approximately over the last five years.
In order to climb up to the previously held $60-$100 billion valuation, 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.”
Cauwels and Sornette also point out that although Facebook's growth has been exponential in the past, it will halt and slow down due to competition, impenetrable markets, limited devices, and--interestingly--a limited world population. So in a best-case scenario, Facebook will cap off at six billion users, and then there's no where left to go but down...
Now who are these guys? Sornette is the director of the Financial Crisis Observatory at the Swiss Federal Institute of Technology and has made a career at studying bubbles and crashes.
2009 was a busy year for Sornette who released three studies during that period. One study looked at bubble terminations, another looked at dropping gold prices, and a third one claimed to predict the date of the Chinese stock market collapse.
All three studies could be filed under the "gloom and doom predictions that haven’t quite come to pass" category, leaving one to wonder about the validity of this latest study.
Overblown valuation or not, any business that can consider the possibility of having every single person on the planet, using their product can be considered a gargantuan success.
Just this past September, a research firm predicted that Facebook revenues for 2011 will reach $4.27 billion. Not too shabby.