By Lauren Silva Laughlin
FORTUNE -- Is Facebook overvalued? The social network's shareholders have fared well since the company went public in mid-2012. Shares are up more than 80% since its IPO and have climbed steadily over the last six months. But investors have paused since Mark Zuckerberg, Facebook's founder, announced on his page two weeks ago that his company was buying WhatsApp, a young but popular social network. The price tag: a shocking $19 billion.
It's not just a matter of digesting the news. Investors already have lofty growth expectations built into the company's stock price. And as the WhatsApp acquisition shows, Facebook (FB) is working hard to justify those assumptions partly with acquisitions -- and it has good reason to do that. Based on at least one metric, a small blip to investors' forecasts could skim nearly a tenth off the stock price.
In many ways, the WhatsApp acquisition makes sense. Scale is important to social networking. Bringing WhatsApp into the fold only makes Facebook that much harder to touch. "The large and rapidly growing user base attracts new advertisers and retailers," Laura Martin of Needham recently said in a report. "We believe the scale of Facebook's network represents a significant competitive advantage and a significant barrier to entry."
However, paying top dollar to grow can turn into a dangerous cycle. "It can be like a dog chasing its tail," said Lawrence Hrebiniak, emeritus professor at The Wharton School of the University of Pennsylvania. If more interesting social networks photo-bomb this growing family portrait, Facebook will have to continue to purchase other companies to keep up.
Jim Chanos, the prominent bearish investor who runs hedge fund Kynikos, is skeptical that scale matters in general. He says he is worried "about the inability of these businesses to 'scale' profitability." "Everyone points to Amazon as their valuation framework safe-harbor, not the scores of Internet road kill." (Chanos is not currently involved with Facebook or similar companies.)
Investors don't necessarily have to choose a side just yet. But it helps to consider how delicate Facebook's stock price actually is, considering the outsize growth expectations for the company. Following Facebook's acquisition of WhatsApp, analysts started to kick around a metric different than one that's often used. Rather than value WhatsApp based on a revenue multiple, analysts showed how much Facebook was paying to acquire each individual WhatsApp user. That magic number was $42 per user ($19 billion for 450 million users).
It seems like a lot considering WhatsApp's business: It takes in 99 cents per user one year after they have signed on. But Facebook's users are worth $122 apiece at its current enterprise value of $167 billion, assuming the company hits Evercore's expectations of around 1.4 billion users by the end of this year.
The hope is that Zuckerberg will add some kind of magic sauce to WhatsApp users so Facebook can jack up their value too. But it may not be that simple. First, Facebook's users are worth more because they bring in more money for the company. Each Facebook user currently adds $6.73 to the top line. Evercore assumes this number will grow a quarter by the end of this year to $8.44, making each Facebook user worth some 14.5 times the revenue they contribute.
Add that to the 16% more people Evercore assumes will join Facebook, and investors have to hope things continue on the up and up.
Say those estimates are a bit off: Revenue per user grows 20% to $8.08. It is still a lot, but not what investors currently assume. And say that users grow a tenth rather than 15%. Each Facebook user at the same multiple (14.5 times) is worth $117, and there are fewer to boot (1.3 billion users), valuing the company at about $151 billion. Add back Facebook's $7 billion of cash, and the market cap of the company is about $158 billion, nearly 10% below its current price.
Small tweaks to a business model that needs to be scaled can be dangerous, especially when investors are paying top prices based on lofty growth assumptions
Target-date funds did well in 2013 for all the wrong reasons.Stephen Gandel, senior editor - Feb 18, 2014 5:00 AM ET
It is understandable that some are comparing recent emerging markets troubles to the Asian financial crisis of 1997. But while it isn't the best time for emerging markets, it is hardly the end of days.Jan 28, 2014 12:16 PM ET
Why the market jolt last week was the start of a sobering reality check for tech stocks.
FORTUNE -- Market prognosticators have conjured up many a reason for the two-day rout of stocks on Thursday and Friday, which sent the Dow Jones Industrial Average (INDU) plunging 494 points (3%) and the S&P 500 (SPX) down 55 points (3%). Some blamed the slowdown in China's perpetual manufacturing machine; others, the fears of MOREShawn Tully, senior editor-at-large - Jan 27, 2014 5:00 AM ET
Facebook is clearly tipping its hand today, saying that its stock is overvalued and the company isn't going to perform as well as the market believes it will.
By Cyrus Sanati
FORTUNE -- Mark Zuckerberg, founder and CEO of Facebook, will sell 41.4 million shares worth of stock in the company, worth $2.3 billion, to pay a tax bill, the company said. He apparently incurred the tax liability when he exercised the option MOREDec 19, 2013 3:00 PM ET
The stock and bond markets have been moving in the same direction lately, and that has some worried.Stephen Gandel, senior editor - Dec 9, 2013 12:28 PM ET
Over the past 10 years or so, trading has become dizzyingly complex and frenetic. So how have investors fared? Surprisingly well.
By Lauren Silva Laughlin; graphics Nicolas Rapp
FORTUNE -- Once upon a time, an ordinary investor -- call him Joe -- would take some of his retirement savings and put it into a giant brand-name mutual fund that advertised in the Sunday paper. The fund would take that money and MOREDec 5, 2013 6:52 AM ET
The largest IPOs of 2013 may not be as sexy as offerings from the latest tech darlings, but they contributed to the biggest year of public offerings since the tech bubble of the early 2000s.Nin-Hai Tseng, Writer - Dec 3, 2013 11:05 AM ET
The market isn't reacting to certain economic news as we might expect, but that doesn't mean it isn't rational.
By Mohamed A. El-Erian
FORTUNE -- So, good news was interpreted as bad news by the markets on Thursday while, on the very next day, good news was indeed good news? Are markets really that fickle? Are convictions really that shallow?
It is tempting to respond yes based on the view that, over MORENov 11, 2013 9:02 AM ET
On Thursday, the S&P 500 hit an all-time high. Stocks will have to leapfrog a drop in earnings for the index to climb even higher.Stephen Gandel, senior editor - Mar 29, 2013 12:55 PM ET
|The medical marijuana ad that never aired, despite contrary media headlines|
|2 million students missing out on college aid|
|China to fight pollution with drones|
|Boeing reports wing cracks on Dreamliners|
|GM raising Corvette prices|