THEORY: Facebook is overvalued

by Lindsey

We the Facebook users know that Facebook is overvalued: we never click ads, we know our status updates aren’t real commodities and most of us have considered deleting our accounts, whether due to Facebook selling our data or stealing our time.

A pair of econophysicists at the Swiss Federal Institute of Technology in Zurich, Peter Cauwels and Didier Sornette, now argue that if we model Facebook user growth based on existing data, Facebook will need to pull off a dramatic increase in per-user profit in order to live up to investor expectations. The chart below presents three scenarios for user growth:

Technology Review sums up Cauwels and Sornette’s findings neatly:

Cauwels and Sornette offer three scenarios in which Facebook eventually plateaus at a base case of 840 million, a high growth case of 1.1 billion or a case of extreme growth reaching 1.8 billion users within a few years. (The graph above shows that Facebook’s growth will probably fall somewhere between the base and high growth scenarios.)

Cauwels and Sornette then calculate a value for the company based on the prospect of each user generating $1 profit per year, the approximate average over the last five years.

This gives a value in the base case of $15 billion, in the high growth case of $20 billion and in the extreme growth case of $33 billion. All these numbers are significantly less than those that are bandied around in the press.

It’s worth pointing out some of the assumptions behind this calculation. It generously assumes that real interest rates are essentially 0% for the next 50 years, that Facebook’s profit margins remain as high in future as they are now and that its revenue per user remains constant in future.

This last one is particularly generous. Cauwels and Sornette have worked out the average revenue per user over the last five years. But the truth is that Facebook’s revenue per user appears to be halving every 3.5 years, a fall that is entirely masked by taking an average.

So these valuations are at the top end of what could be called reasonable calculations.

They imply that if the current valuations are to be achieved, Facebook will somehow have to improve its profit per user by between 1.5 and 6 times.

Good luck, Facebook! Ref: arxiv.org/abs/1110.1319: Quis Pendit Ipsa Pretia: Facebook Valuation And Diagnostic Of A Bubble Based On Nonlinear Demographic Dynamics