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1. How does Facebook make money? What are the value drivers of its business?
What is its comparative advantage relative to other social networking
companies?
(1) Facebook makes money from the following three main fields
First is the advertising. According to the case, we know that the major revenue of
Facebook is advertising, which took up 98 percent in 2009, 95 percent in 2010 and 85
percent in 2011. Facebook uses all information uploaded by users to become the
property of the firm. By analyzing database, Facebook provides advertisers target
customized services and products based on users preferences and connections. In its
view, the advertising which based on social context could be better received by
consumers.
Second is the sale of virtual goods. The majority of Facebooks payment business
comes from the sale of virtual goods, which was sold to the online gaming company
as social games. According to the data we can see that the revenue of virtual goods
sale is increasing enormously.
Third is about geography. According to the case we know that about 56 percent of
Facebooks 2011 revenues came from the United States.
(2) The value driver of Facebook is everything that can be added to the service in
order to increase the value to users. As a company, Facebooks own products and
services can be divided into two aspects, social network service for common users and
directional advertising platform for advertising companies. The first aspect, for
common user, the value driver of Facebook is excellent user experience. Specifically,
the simple and clean user interface (UI) can be widely accepted and Facebook has
powerful server to guarantee the rapid website response. The second aspect, for
Advertising Company, the core value driver of Facebook is social context, the
feature that advertisers could directionally deliver advertisements based on the big
data that Facebook collected from every users preferences and connections.
(3) Compared with other social networking companies, Facebook has three main
comparative advantages as follow:
(a) Huge number of users
Facebooks target market is quite broad, which attracts a huge number of users. It
categorized its users into monthly active users and daily active users. According to the
source from Facebook, the number of monthly users is increasing quickly, from one
million in 2004 to around 845 million in 2011. Also, the New Pew Research Center
survey findings show that half of the Facebook users have more than 200 friends,
which means that the market of Facebook is really huge.
(b) Business Model
In the current market, the big data plays an important role in a company, which is
regarded as an important capital of the company. Facebook makes good use of the
information uploaded by users to become the property of the company. By using the
data, Facebook gets to know users consumption behaviors, preferences and
connections. These data not only help Facebook gain a majority of revenue from
advertisers, but also provide much information, which could assist Facebooks further
development and satisfy the increasing demand of consumers.
(c) Acquisition
Acquisition is not only an important way to improve the structure of a company, but
also the most efficient one. Facebook, as an integrated social network service, has a
broader target market than its competitors, such as LinkedIn, which focuses more on
professional connection area. Hence, by buying Instagram, Parakey, FriendFeed, it
could help company absorb more talents, get various technologies and build up its
core competitive advantages.
2. Why is Facebook going public? What is the planned use of proceeds from the
offering?
(1) The reasons that Facebook going public are as follow:
First, the objective situation forces Facebook to go public. From 1964, an antiquated
Securities and Exchange Commission rule requires that any private company with
more than 500 shareholders of record have to adhere to the same financial disclosure
requirement that public companies do. As Facebook realized that it tends to exceed
500 shareholders, it would trigger a requirement to start publicly releasing financial
details.
Second, by going public, Facebook can raise funds from a broader base of investors.
With much money, the company can have enough resources to develop new products
and invest in their business, which make the company become more competitive.
Meanwhile, its a good opportunity for the shareholders to gain the best possible value
for their own stakes in a long term.
Third, for the further development, Facebook raises its reputation and amplifies its
brand value. More people get to know the company and join in the Facebook. That is
to say, Facebook attracts more users and expands the market share.
(2) According to the case, proceeds from the offering will be used for working
capital and other general corporate purposes. Facebook didnt say more about the use
of proceeds in details.
3. What was transpiring in the US IPO market prior to Facebooks offering?
What has been the performance of recent IPOs (during the lead-up to the
Facebook offering)?
(1) According to the case, global IPO activity during the first quarter of 2012 fell
to $14.3 billion, which was dramatically down from $46.6 billion during the first
quarter of 2011. In addition, we can see in Exhibit 5 that IPO activity in US have
dropped sharply since the second quarter of 2011. Number of deals dropped from 383
in the second quarter of 2011 to 157 in the first quarter of 2012. Raised capital also
decreased by $52 billion in this period, from $66 billion to only $14 billion.
(2) In the case, Mr. McNeil and his team had analyzed the performance of recent
IPOs by LinkedIn, Groupon and Zynga. Performance of these three IPOs is shown in
Table-1. Data in Table-1 are from Exhibit-6 in the case.
price range, its performance was not good either. So we can conclude that there was a
downturn in IPO market at that time.
4. What is the intrinsic value of a Facebook share? How does this value compare
to the price being discussed by the underwriters?
(1) The basic approach to value Facebook is a discounted cash flow (DCF)
analysis. In this case, the DCF analysis was based on the assumptions from Professor
Aswath Damodaran, NYU Stern School of Business.
The following are the main assumptions from Prof. Damodaran, according to Exhibit
11. Attention, some data are different from those in Exhibit 11. (All the assumptions
are for the period of next 10 years from 2012 to 2021.)
Revenue growth rate will remain 40% in next 5 years. Then the growth rate will
decrease by 7.6% per year after 2016 and in the terminal year of 2021, the growth rate
will be 2%.
Operating margin will decrease linearly from 45.7% in 2011 to 35% in 2021.
Tax rate will remain 40% until 2017 and will then decrease by 1% per year. The
terminal tax rate will be 35%.
Increase in capital expenditure (CAPEX) and working capital (WC) will remain 67%
of increase in sales (revenues) each year.
WACC will remain 11.0% until 2017 and will decrease linearly to 8%.
Other assumptions and data used are in the Excel files.
The process of calculation is shown in Table-2. The estimated price is $32.3 per share.
(This table can be found in the Excel files.)
public's enthusiasm for Facebook IPO, its stocks would tend to be bought rather than
sold in a short time. Therefore, the stock price would increase in a short time. This is a
good chance for short-time trade. Secondly, because our estimated Facebook's
intrinsic value is below the open price of its IPO, $38, it means that there is a big
probability that Facebook's stock price would fall below the open price after public's
enthusiasm coming down. After its price cool down, it is a good chance for
CXTechnology Fund to buy the stock. Thirdly, CXTechnology Fund should analyze
the future trend of the stock price constantly, and then make decision that when to buy
and sell stocks. At last, do not overbuy the stock. Besides the Facebook's stock,
CXTechnology Fund should add other companies' stocks into its investment portfolio
to disperse the risk.