‘If you call lemonade ‘lemonada,’ you can charge $2 more.’ –Tim Geoghegan
Placing a value on a company is always a tricky business. History is filled with examples of disastrous valuations that are hard to credit in retrospect. The dotcom bubble of the late 90s is one of the best known examples.
And yet crazy valuations continue apace. One current bubble involves social media companies such as LinkedIn, Twitter, Groupon and, of course, Facebook. In July, the latter announced that it had 750 million users, an astronomical number that is dwarfed only by the company’s valuation which stands at anything from $65 billion to north of $100 billion.
By that measure, the company’s current and future users will each have to generate a remarkable amount of income for the company, numbers that reek of the boom and bust economics of the dotcom era.
So how much is Facebook really worth? Today, Peter Cauwels and Didier Sornette, econophysicists at the Swiss Federal Institute of Technology in Zurich, inject a little sanity into the debate. They argue that it is actually easier to value social media companies than other firmS because their revenue is so obviously based on a singe simple metric: the number of users.
All that is required is a reasonable model of user growth and a good understanding of the profit each user can generate.
For Facebook, user growth is pretty straightforward. Cauwels and Sornette argue that although Facebook’s growth has been exponential in the past, this cannot continue if only because of the finite number of people on the planet. Instead, Facebook user numbers will eventually level off, following a classic s-shaped curve.
Indeed, they say Facebook’s growth has already changed. In 2010, they say it switched from exponential to s-shaped.
The only question now is how high it will reach. 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.
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.
