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. Illustrating
the methodology with facebook, one of the biggest of the social-media giants,
we find 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 describing the evolution towards an
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.