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Facebook, Inc.: The Initial Public Offering – Case Solution

In mid-May 2012, the pricing of Facebook Inc.'s initial public offering (IPO) was undertaken. A CXTechnology Fund analyst looked forward to speaking with the lead underwriter about his interest after a review of Facebook Inc's phenomenal growth as well as its potential for profit as a business and in the competitive environment of social networking. The analyst had to come up with the decision whether to subscribe to shares in the IPO or not, considering that the IPO appeared to be oversubscribed with heavy interest, and the valuation seemed to be much more.

​Deborah Compeau; Craig Dunbar; Michael R King; Ken Mark Harvard Business Review ( W12453-PDF-ENG ) January 25, 2013

Case questions answered:

Case study questions answered in the first solution:

• Why is Facebook going public? How much money would the company raise from the IPO? What is the planned use of proceeds from the offering?
• Exhibit 11 provides an estimate for Facebook’s share value using DCF. How sensitive is the valuation to assumptions on revenue growth, margin, and the WACC? Do you agree with these assumptions? If not, how would the valuation change based on your modification?
• Provide an estimate for Facebook’s share value using market multiples. Explain your choice of comparable firms and multiples.
• As a potential shareholder, do you have any concerns about Facebook or its stock offering?
• The Ultimate Question: Do you recommend CXT to invest in Facebook’s initial public offering given the current price talk ($34 – $38)?

Case study questions answered in the second solution:

• How does Facebook Inc. make money? What are the value drivers of its business? What is its comparative advantage relative to other social networking companies?
• Why is Facebook going public? What is the planned use of proceeds from the offering?
• What was going on in the U.S. IPO markets prior to Facebook’s offering? What has been the performance of recent IPOs?
• What is the intrinsic value of a Facebook share? How does the valuation compare to the price talk from the underwriter?
• As a potential shareholder, what are your concerns about Facebook or its stock offering?
• What is your recommendation for the CXT Technology Fund?

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Facebook, Inc.: The Initial Public Offering Case Answers

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Executive Summary – Facebook, Inc.

Facebook Inc. is a social media application that Mark Zuckerberg founded in February 2004. The app was designed to use modern science and technology that allowed users to connect with people around the world.

Facebook’s users had increased drastically from 500 million in 2010 to 900 million in 2012. Based on the rising popularity and publicity of Facebook, it was merely a question of time before the company went public.

As Facebook planned to go public, the initial stock price range was between the $20s to mid-$30s per share; however, the price talk had raised its IPO price to $34 to $38 per share.

The chief analyst of CXTechnology Fund, McNeil, judged the riskiness of overpaying  Facebook’s IPO price. Yet, he did not want to miss this substantial opportunity, which could make CXTechnology profitable as well.

For this reason, McNeil would like to recommend that CXTechnology should invest in Facebook’s IPO and a proper price range of the stock.

Problem Overview

There are two main reasons why Facebook Inc. had to go public.

First of all, “the principal purposes of the IPO were to create a public market for the existing shareholders and to enable future access to the public equity markets” (case p.2). To be more specific, by going public, Facebook can raise funds from a broader pool of investors.

Using these funds, Facebook can develop additional capital or products that can make the company more competitive. By going public, Facebook can attract more investors to join the company to increase its funds and expand its market share.

In addition, mobile users have been an important contributor to Facebook’s growth, reaching 483 million daily active users worldwide in 2011.

Before the IPO, Facebook was unable to show ads to mobile users. Facebook needed to find a solution before it threatened to cannibalize the company’s advertising revenue.

Another reason IPO is attractive to Facebook is that the fees for underwriting listings were just 1.1 percent because of the growing prestige of the offering, compared with the typical 3 to 7 percent of the amount raised for equity IPO.

The underwriters also gave Facebook Inc. an overallotment option (“greenshoe”) to sell an additional 15% of the offering, up to 484 million shares (case p.7).

Another essential reason is that there were too many shareholders, which passed 500 million by 2010.

An antiquated Securities and Exchange Commission rule from 1964 says that “any private company with more than 500 ‘shareholders of record’ must adhere to the same financial disclosure requirements that public companies do, which means submitting detailed quarterly and annual financial reports, and dealing with all the scrutiny that powerful companies face when they open their books” (Paul Sloan).

Facebook would raise $6.1-6.8 billion from the IPO. According to the case, Facebook was willing to sell $421,233,612 shares and sold its shares at $34-38. The number of shares was made up of issuing 180,000,000 shares and 241,233,615 shares sold by existing stockholders.

Therefore, the total money raised from the IPO equaled the total number of shares multiplied by the price per share, whose result was also the same as $6.1-6.8 billion in the case.

According to the case, the planned use proceeds will be used for working capital and other general corporate purposes.

We estimated the other general corporate purposes would be operating expenses (which included the costs of broadening the number of users, research and development costs), acquisition costs, and investment costs (such as bonds and money market funds). Other potential costs may be the cost in which Facebook Inc. figures out a solution that allows ads to be displayed on mobile devices.

Original Sensitivity Analysis

Based on the DCF Valuation from the case, we did a sensitivity analysis on the assumptions of growth rate, terminal growth rate, terminal EBIT Margin, WACC, and terminal WACC.

We chose a 1% increase and decrease based on the case assumptions, then calculated the price change with each one percent change in those assumption values.

Table 1 shows the price change when each variable increases or decreases by 1%. Facebook’s estimated value/share was $35.47 based on Professor Aswath Damodaran’s assumptions.

Table 1: Sensitivity Analysis Based on Case Assumptions

To compare which variable has the highest sensitivity to Facebook Inc.’s stock price, we made a graph for the stock price change based on a…

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Finance & Accounting Case Study | Authors :: Deborah Compeau, Craig Dunbar, Michael R King, Ken Mark

Case study description.

It was May 16, 2012, and the highly anticipated pricing of Facebook Inc.'s initial public offering (IPO) was underway. An analyst at CXTechnology Fund was preparing to speak to the lead underwriter about his final interest in the deal. The analyst had reviewed Facebook's phenomenal growth, its profitable business model and the competitive landscape for the social networking industry. The IPO appeared to be oversubscribed with heavy interest from institutional and retail investors alike, but the valuation seemed expensive, even by technology standards. The analyst needed to make a decision on whether to buy shares in the IPO or not. A spreadsheet for students is available, product 7B12N031.

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Facebook, Inc: The Initial Public Offering Harvard Case Solution & Analysis

Home >> Harvard Case Study Analysis Solutions >> Facebook, Inc: The Initial Public Offering

Facebook, Inc: The Initial Public Offering Case Solution

Introduction:

Facebook was launched by Mark Zuckerberg and his friends in 2004 with the key objective of connecting people online. Facebook has a record of rapid growth which drastically improved its financial position. From a journey of database of 1 million monthly active users in 2004, it reached a figure of 845 million monthly active users and 522 million daily users. The purpose of this case is to provide a proper algorithm for valuation multiples used by Facebook to incorporate a positive financial growth.

Sources of Revenue:

Facebook generates 85% of its revenue from the advertising sector. This is done as there are more likes on an advertisement, then as a result it increases the revenue of Facebook. Facebook uses a database that is used by advertisers to target the users having similar interests required in selling or buying of product or service. The database compelled from the information uploaded by users enclosing their interests, preferences and identities. Facebook analyzes this information in connection with friends of users and it is known as social context.

Other revenues generated by Facebook are from its online payment business. These come from virtual goods offered by online games and buying of virtual goods, which resulted in the company generating a revenue of $557 million in 2011. Facebook has collaboration with gaming portals to enhance its sales of virtual goods.

Recently, Facebook initiated its mobile application, which affected its revenues, as a result another source of revenue was made for the company.

The value drivers:

The key component for the success of Facebook’s business model is to start with a successful roadshow. The roadshow would come up with a publicly announced presentation of figures of increasing user interactions on Facebook. Moreover, Facebook should influence the investors by showing them the amount of profit it would generate if more users join.

The case identifies Underwriters as another value driver, which would influence Facebook’s business model. Underwriters always have an influence on investors by recommending them perfect investment options. The acquisition of Instagram can lead Facebook to a major conflict for its initial public offering. Underwriters play a major role in resolving the conflict by putting maximum efforts on discussing the benefits of the acquisition of Instagram.

Other approaches that help in the success of the business model as reality,not a dream are Market Multiple Valuations and Discounted Cash Flows. It is important for Facebook to increase its growth rate of revenue, increase its growth of operating income from operations and growth of revenues from mobile users. The increase in the growth rate of cost of revenues should also be minimized by Facebook. Facebook should also compare its target range of price with other competitors.

The values of discounted cash flows are good for short term investor. In addition to this, Facebook gets its revenues from mostly of advertisement. Moreover, it is expected to increase online advertisement in the near future.

Motivations for Facebook Inc. to go public

Facebook is on its path of rapid growth. In just eight years, the company has attracted 845 million monthly users and recorded revenue of $3.7 billion. After IPO, the worth of Facebook is expected to be $100 billion. The figures make it one of the largest IPO by a social networking company. The consolidated financial statement of Facebook highlights some of its major reasons and motivations to go public.

Facebook stated that the initial public offerings are for its investors to craft their equity stakes into cash. Facebook rapidly introduces a variety of innovative online tools, as well as it has an additional advantage of public enterprise while getting loans from financial institutions for its innovations. Moreover, it will also able to get more funds by issuing more stocks. Facebook can also look for other mutual funds.....................

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Facebook, Inc.: The Initial Public Offering

By: Deborah Compeau, Craig Dunbar, Michael R King, Ken Mark

It was May 16, 2012, and the highly anticipated pricing of Facebook Inc.'s initial public offering (IPO) was underway. An analyst at CXTechnology Fund was preparing to speak to the lead underwriter…

• Length: 20 page(s)
• Publication Date: Jan 25, 2013
• Discipline: Finance
• Product #: W12453-PDF-ENG

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It was May 16, 2012, and the highly anticipated pricing of Facebook Inc.'s initial public offering (IPO) was underway. An analyst at CXTechnology Fund was preparing to speak to the lead underwriter about his final interest in the deal. The analyst had reviewed Facebook's phenomenal growth, its profitable business model and the competitive landscape for the social networking industry. The IPO appeared to be oversubscribed with heavy interest from institutional and retail investors alike, but the valuation seemed expensive, even by technology standards. The analyst needed to make a decision on whether to buy shares in the IPO or not. A spreadsheet for students is available, product 7B12N031.

Learning Objectives

The case introduces both MBA and undergraduate students to advanced issues in corporate finance. Students are faced with a fast-growing, high-profile company from a new industry where the potential earnings outlook is uncertain. Students learn about the dynamics of the IPO market, the incentives of different parties (company, insiders, underwriters, new shareholders) and their potential conflicting interests. It is hard to establish a valuation for Facebook's shares despite having a third-party fundamental valuation and market multiples from both precedent transactions and comparable companies. Through the discussion, students learn that equity valuation is both an art and a science. They also review the steps involved in a U.S. IPO.

Jan 25, 2013 (Revised: Mar 13, 2014)

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Ivey Publishing

W12453-PDF-ENG

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Facebook, Inc: The Initial Public Offering Case Solution & Answer

Home » Case Study Analysis Solutions » Facebook, Inc: The Initial Public Offering

Facebook, Inc: The Initial Public Offering Case Solution

Facebook can offer its stock in case of acquisition of a company such as Instagram. The credibility and exposure to the public will also be increased by registering in a stock exchange.Facebook is on an increasing trend;only a few companies have achieved such growth in a short span of time on such a huge scale. The statements show a huge amount of equity invested in Facebook. Its planned IPO continues to meet up a tax obligation that will be generated by going public.

The IPO is planned in such a manner that the CEO will still have most of the control over voting rights. Meanwhile, the CEO doesn’t want to lose his control over Facebook as he has worked hard in the establishment of the company.

Mark Zuckerberg has command over appointments of directors and he can control and manage different internal affair of Facebook. He has 28% privileged class B shares of Facebook.He further manipulates surrogate control of 30% of Facebook’s class (A) share.However, this would not be beneficial for the company in the long run.

Worth of Facebook share

Facebook has been facing an immediate decline in its share price. A decline can be seen in IPOs of Group on and Zynga, whereas Linked In has increased its share price.Facebook has initiated its IPO at around $28-$35 dollars at an estimated value of $100 billion and later shifted to a price $38 per share. Facebook increased its IPO tremendously as it is 100 times of its total earnings per share and 26 times of its sales per share.

According to the discounted cash flow analysis, the IPO was estimated at a value of $32.44. The price of IPO is 117% of estimated price per share. Facebook generates 85% of its revenue from advertisement and it has a database of over 901 million monthly users and 526 daily users. The valuation for the IPO is 100 times its earnings, which  means its earning yield ratio is1%. The net yield ratio of the company will be reduced to.85% by paying 15% tax dividends if the company pays its profits as dividends to shareholders. However, this will consume a lot of time to increase the capital invested on the company.

There are two prices recommended to the company. The first recommended price for Facebook is computed by taking its mean multiples for enterprise value per sales,which are 4.1 as compared to Facebook’s 11.2.By changing it with mean multiples, we get an IPO of 14,while the other is Damodaram estimated price, which is $32.44

Recommendation

The figures conclude that Facebook was overvalued in terms of its IPO. However, now Facebook is looking to raise a total of 421,233,615 shares of Class A.The hype produced by Facebook will cool down after a certain period of time and the price for its share will also reduce, as a result it will take few years for Facebook to be stabilized.

It will be exciting to see how Facebook will operate as a public company. Information regarding Facebook should be considered for future investments. Mark should watch over the activities of the IPO. Moreover, he should also review reaction of stockholders and reaction by the company on it.

Mark Zuckerberg owns 28% percent of shares with a right of 56% on the company’s decisions. This figure depicts an autocratic approach, which can lead the company to its downfall as the performance of the overall company will deteriorate as the decision will be solely on the CEO.An example of acquisition of Instagram can be seen in this case. The decision of acquisition was solely taken by Mark Zuckerberg as he did not take advice from financial advisors. Decisions like these can be appreciable for private companies but can cause huge loss for public entities.

Other factor which led Facebook to set an IPO of $38 was the increase in the users of its mobile application.Thus, it can be seen that Facebook offers a free version of its application. However, this factor will not cause a boom in the revenue as most of the people have shifted from desktop to mobile. It is also not proven that Facebook will succeed its ambitious in mobile world………………..

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