Facebook is set to price its historic IPO later this week at a reported valuation of over $100 billion. This is huge given how young the company is and the competition it faces from the likes of Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Yahoo (NASDAQ:YHOO) for online advertising dollars and a host of smaller competing social networking offerings like Twitter, Google+, LinkedIn (NYSE:LNKD) and Pinterest. Nonetheless we believe the rumored IPO range is ahead of fundamentals which we value at $82 billion and detail below.
Facebook makes money primarily from text and display ads and virtual transactions on its platform.
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We have broken down Facebook’s model into three main businesses, which we think will account for a major portion of its value going forward.
Facebook’s Primary Revenue Engine: Social Advertising
Socially powered text and display advertising is Facebook’s most valuable business. It accounted for nearly 85% of Facebook’s overall revenue in 2011, and is expected to remain its most lucrative revenue engine going forward.
Facebook offers a self-serve advertising platform for advertisers, which enables them to create text ad units and target them to users based on their social demographic data. Going forward, we expect its active user base to more than double by the end of the forecast period, which when coupled with the increase in average ad revenue generated per user, should lead to a steady growth in social text and display ad revenue for Facebook.
This business is still not a given as recent grumblings, most notably by GM, have raised concerns that ad spending on Facebook is not paying off just yet.
Virtual Goods Transactions
Facebook operates one of the world’s largest application/game platform, enabling developers to create their own apps and games and leverage Facebook’s massive audience to grow their user base quickly and generate revenue through in-game advertising and the sale of virtual goods.
Facebook currently takes a 30% revenue share off each virtual transaction on its platform through Facebook Credits, its virtual currency. As the virtual goods economy and the online gaming scene explodes in the coming years, and the average virtual goods spend on Facebook’s platform goes up going forward, we expect Facebook to generate a significant amount of revenue through this business. Besides the expected increase in active users, we also expect the average virtual goods spend per Facebook user to increase steadily going forward.
We have a $82 billion Trefis valuation estimate for Facebook, which translates to a $33 Trefis price estimate based on its diluted share count.