Stocks and Their Valuation

1. Stock valuation - A comparison of estimated values and marketprices Slim Perkins, a business Journalist, is a recent hire at his firm. Since he joined the firm, he has been following Facebook Inc.'s (FB) initial public offering (IPO) and the stock's performance. His task is to estimate Facebook's fair market value, also referred to as "intrinsic" value, and compare this value with the current stock price, and recommend a buy, sell, or hold rating to investors. Slim pulls the company's consolidated financial statements to collect relevant data on the company's historical financial performance. He notices that the company assumes a 45% marginal tax rate after the IPO, and mentions that the company projects that user rates and revenue growth will decline over time. Slim starts his evaluation by calculating ratios of costs and expenses to revenues, interest expense to revenues, and others that will form the set of assumptions in his analysis which will be used to calculate free cash flows. 421,233,615 Shares FACEBOOK CLASS A COMMON STOCK 2011 (in millions) 2010 (in millions) 2009 (in millions) Assets Cash and cash equivalents $3,908 $633 $1,785 373 Receivables 547 Prepaid expenses and other current assets 149 88 Total current assets $4,604 $2,246 574 1,475 $148 Property and equipment, net Goodwill and intangible assets, net Other assets 162 96 90 74 Total assets $6,331 $2,990 $1,109 Liabilities and equity Accounts payable Platform partners payable Accrued expenses and other current liabilities Deferred revenue and deposits Current portion of capital lease obligations 279 42 106 $389 117 Total current liabilities $899 398 Capital lease obligations, less current portion Long-term debt Other liabilities 250 IIIIIIIIIIII ! 135 1,432 615 2,684 Total liabilities Convertible preferred stock Common stock Additional paid-in capital Accumulated other comprehensive loss Retained earnings Total stockholders' equity Total liabilities and stockholders' equity (6) 1,606 $4,899 $6,331 947 (6) 606 $2,162 $2,990 $868 Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows 2011 (in millions) $3,711 2010 (in millions) $1,974 2009 (in millions) $777 Revenue 493 184 144 388 280 121 $1,955 $942 $1,032 $515 $262 $1,756 Costs and expenses Cost of revenue Marketing and sales Research and development General and administrative Total costs and expenses Income from operations Interest and other income (expense), net: Interest expense Other income (expense), net Income before provision for income taxes Provision for income taxes Net income Net Income attributable to participating securities Net income attributable to class A and class B common stockholders $(22) $(10) $(42) (19) $1,695 695 $1,008 $254 402 $1,000 $606 $229 332 234 $668 $372 $122 Balance Sheet Income Statement Statement of Stockholder's Equity Statement of Cash Flows Balances at Dec 31 (in millions) (in millions) (in millions) 2011 2010 2009 $615 $615 $615 2,684 253 Convertible preferred stock Class A and Class B common stock Additional paid-in capital Accumulated other comprehensive loss Retained earnings (accumulated deficit) Total stockholders' equity (6) 947 (6) 606 $2,162 1,606 $4,899 $868 2011 (in millions) 2010 (in millions) 2009 (in millions $1,000 $606 $229 323 139 Cash flows from operating activities Net income Adjustments to reconcile net earnings to net cash from operating activities: Depreciation and amortization Loss on write-off of assets Share-based compensation Other adjustments Changes in assets and liabilities: Accounts receivable Prepaid expenses and other current assets Other assets (1) (174) (209) (38) (112) (30) Accounts payable Platform partners payable Accrued expenses and other current liabilities Deferred revenues and deposits Other liabilities Net cash provided by operating activities Cash flows from investing activities Purchases of property and equipment Purchases of marketable securities Maturities of marketable securities $1,549 $698 $155 $(293) $(33) $(606) (3,025) 516 113 (22) Sales of marketable securities Investments in non-marketable equity securities Acquisitions of business, net of cash acquired Change in restricted cash and deposits Net cash used in investing activities Cash flows from financing activities (32) $(62) $(3,023) $(324) $200 $998 $500 28 250 Cash flows from financing activities Net proceeds from issuance of convertible preferred stock Net proceeds from issuance of common stock Proceeds from exercise of stock options Proceeds from (repayments of) long-term debt Proceeds from sale and lease-back transactions Principal payments on capital lease obligations Excess tax benefit from share-based award activity Net cash provided by financing activities Non-cash financing activities: Property and equipment acquired under capital leases (250) 170 (181) 433 (90) 115 51 $243 $1,198 $781 473 217 Complete the following table. Note: When entering intermediate calculations, round to two decimal places, but do not round the intermediate calculations when determining final answers. Round all percentages to two decimal places 2010 2009 Average Estimated Assumptions 1. Total cost and expenses as a percentage of revenue 2. Operating current assets (in millions) 3. Growth in operating current assets 4. Operating current liabilities (in millions) 5. Growth in operating current liabilities 6. Depreciation and amortization as a percentage of revenues 7. Net fixed assets as a percentage of revenues Slim posts his strategy on his social networking page to get some suggestions from his friends. Follow the discussion and complete the missing information: Since Facebook named Google as its prime competitor, 1) I am inclined to use Google Inc.'s post-IPO performance as a benchmark for FB's expected financial performance for at least three to four years following the IPO. Does anyone already have the growth rates for Google's post-IPO revenues? NATALYA: Hi Slim, according to a trading blog 21 I follow, Google's post-IPO average revenue growth over five quarters was 18%. SLIM: Thank you, Natalyal I also discovered in the annual report that FB's internal projections use a 5% perpetual growth rate. I will be using a two-stage discounted cash flow model. I will base my FCF calculations on the following equation: FCF = Net Operating Profit After Taxes + Depreciation - Capital Expenditure - A in Net Operating Working Capital Am I missing something? TED: Slim, just one very important point. In your NOWC calculations I recommend using the growth in current assets as the assumption for growth in current liabilities after two years because current liabilities cannot grow faster than current assets forever. Such rundown on WC is not sustainable. You could use Google's WACC in your calculations. Google is currently using a 9.5% WACC. Investors would require an additional premium of 3.5% for Facebook's stock. SLIM: Thanks, Ted! This information is really helpful. Using Google as a comparable, it would be fair to use these values to calculate Fe's investors' required rate of return, which will be