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Quis pendit ipsa pretia: facebook valuation and diagnostic of a bubble based on nonlinear demographic dynamics

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  • Peter Cauwels, Didier Sornette

Abstract

We present a novel methodology to determine the fundamental value of firms in the social-networking sector, motivated by recent realized IPOs and by reports that suggest sky-high valuations of firms such as Facebook, Groupon, LinkedIn Corp., Pandora Media Inc, Twitter, Zynga. Our valuation of these firms is based on two ingredients: (i) revenues and profits of a social-networking firm are inherently linked to its user basis through a direct channel that has no equivalent in other sectors; (ii) the growth of the number of users can be calibrated with standard logistic growth models and allows for reliable extrapolations of the size of the business at long time horizons. We illustrate the methodology with a detailed analysis of Facebook, one of the biggest of the social-media giants. There is a clear signature of a change of regime that occurred in 2010 on the growth of the number of users, from a pure exponential behavior (a paradigm for unlimited growth) to a logistic function with asymptotic plateau (a paradigm for growth in competition). We consider three different scenarios, a base case, a high growth and an extreme growth scenario. Using a discount factor of 5%, a profit margin of 29% and 3.5 USD of revenues per user per year yields a value of Facebook of 15.3 billion USD in the base case scenario, 20.2 billion USD in the high growth scenario and 32.9 billion USD in the extreme growth scenario. According to our methodology, this would imply that facebook would need to increase its profit per user before the IPO by a factor of 3 to 6 in the base case scenario, 2.5 to 5 in the high growth scenario and 1.5 to 3 in the extreme growth scenario in order to meet the current, widespread, high expectations. To prove the wider applicability of our methodology, the analysis is repeated on Groupon, the well-known deal-of-the-day website which is expected to go public in November 2011. The results are in line with the Facebook analysis. Customer growth will plateau. By not taking this fundamental property of the growth process into consideration, estimates of its IPO are wildly overpriced.

Suggested Citation

  • Peter Cauwels, Didier Sornette, "undated". "Quis pendit ipsa pretia: facebook valuation and diagnostic of a bubble based on nonlinear demographic dynamics," Working Papers ETH-RC-11-007, ETH Zurich, Chair of Systems Design.
  • Handle: RePEc:stz:wpaper:eth-rc-11-007
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    References listed on IDEAS

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    1. Fernandez, Pablo & Aguirreamalloa, Javier & Corres, Luis, 2011. "US market risk premium used in 2011 by professors, analysts and companies: A survey with 5.731 answers," IESE Research Papers D/918, IESE Business School.
    2. Fernandez, Pablo & del Campo, Javier, 2011. "Market risk premium used in 2010 by analysts and companies: A survey with 2.400 answers," IESE Research Papers D/912, IESE Business School.
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    Cited by:

    1. Paolo Pellizzari, 2012. "Facebook as an academic learning platform: A case study in Mathematics," Working Papers 2012_01, Department of Economics, University of Venice "Ca' Foscari".
    2. Graef, Inge, 2015. "Mandating portability and interoperability in online social networks: Regulatory and competition law issues in the European Union," Telecommunications Policy, Elsevier, vol. 39(6), pages 502-514.
    3. Feijóo, Claudio & Gómez-Barroso, José Luis & Voigt, Peter, 2014. "Exploring the economic value of personal information from firms’ financial statements," International Journal of Information Management, Elsevier, vol. 34(2), pages 248-256.
    4. Spencer Wheatley & Didier Sornette & Tobias Huber & Max Reppen & Robert N. Gantner, 2018. "Are Bitcoin Bubbles Predictable? Combining a Generalized Metcalfe's Law and the LPPLS Model," Papers 1803.05663, arXiv.org.
    5. Zal'an Forr'o & Peter Cauwels & Didier Sornette, 2011. "Valuation of Zynga," Papers 1112.6024, arXiv.org.
    6. Schneider, Lorenz, 2014. "Firm value in emerging network industries," Information Economics and Policy, Elsevier, vol. 26(C), pages 75-87.

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