Facebook's IPO valuation methods and first-year stock performance

Company Valuation

Facebook IPO Valuation Method

In accordance to the Securities Exchange Commission (SEC) Registration Statement Form S-1, Facebook's Initial Public Offering (IPO) method of valuation encompassed considering several objective and subjective factors to ascertain their best estimate of the fair value of their Class B common stock. The factors included latest private stock sale transactions, historical financial results and projected trends, and projections for Facebook's future financial performance. There was also the factor of the performance and market position in relation to competitors and identical publicly traded corporations. Another factor was the economic and competitive setting, taking into account the industry in which Facebook operates and independent third-party valuations completed at the end of every financial quarter (Securities Exchange Commission, 2012).

The valuations of the Facebook IPO took into consideration the aforementioned factors and also employed a combination of financial and market-based methodologies to ascertain the firm's business enterprise value (BEV). One of the methods used was the Discounted Cash Flow Method (DCFM). This approach encompasses projecting the future cash flows of a company for a particular discrete time and discounting such cash flows to present value. The discount rate mirrors the risks intrinsic in the cash flows and the market rates of return accessible from substitute investments of identical kind and quality as of the valuation date (Securities Exchange Commission, 2012). A second method that was used in the IPO was the Guideline Public Company Method (GPCM). This method makes the assumption that businesses operating in the similar industry will have mutual features and that the subject's business will be in correlation to those features. The GPCM delivers an approximation of value by means of multiples resulting from the stock prices of publicly traded firms. The third approach is the Market Transaction Method (MTM). This methodology lays emphasis on the equity securities of the business or company being valued. In 2011, there were private stock sale transactions in Facebook's common stock. These transactions are considered if they take place with or amid prepared and unconnected parties. For Facebook's MTM approximations, all transactions were evaluated in the quarter with specific attention on transactions that are nearer in immediacy to the valuation date (Securities Exchange Commission, 2012).

Facebook's IPO price was botched from high anticipations and owing to a number of miscalculations. One of the miscalculations is that two days prior to the IPO, Facebook altered its decision regarding the number of shares it would offer. This caused an error simply because the key players that planned on buying shares on the IPO day had to recalculate all aspects and update their plans. In addition, several of the initial institutional investors recounted in the days prior to the IPO day that they planned to sell some of the shares they would receive (Bhuptani, 2013).

First Year Performance of Facebook IPO

The performance of Facebook's stock within its first year after the IPO was remarkable, surpassing all market expectations. A key driver of Facebook's performance was mobile. The CEO of the company asserted that mobile was a major area of focus for the firm in driving its results. Products such as Home and Graph Search were massive prospects to render some distinctive and significant services to the world that the firm was well positioned to perform better than any other firm (Market Watch, 2013). In turn, Facebook reported a profit of $219 million equivalent to 9 cents per share. The revenue generated by the company increased to $1.46 billion from the previous year's $1.06 billion. This surpassed the market projections of $1.44 billion. Mobile revenue was largely the driving factor, representing about 30% of the total advertising revenue, which rose up to 43% (Pimentel, 2013).

Role of the Chief Executive Officer in Relationship to the Stock Performance

The Chief Executive Officer (CEO) plays a significant role in relation to the performance of the stock. In general, the CEO is responsible for the everyday running and operation of the firm, which plays a significant part on how the stock performs. In this case, the CEO of Facebook Inc., Mark Zuckerberg, maintains a majority of the voting power as the company has two classes of stock, Class A and Class B. As the CEO, he owns 50% of Class B common stock. It is imperative to note that shares of Class A are entitled to one vote for each share they hold; on the other hand, shares involving Class B are entitled to ten votes for each share. Zuckerberg therefore has the ability to control the outcome of matters submitted to the stakeholders for approval, encompassing how the directors are elected. It is imperative to note that Zuckerberg is not only the CEO of Facebook, but also the co-founder of the company. Therefore, it can be deemed that he would not have done it different simply because his main objective is to not only generate revenue for the stakeholders, but largely to come up with products and services that will make the company sustainable in the long-term. This is varying from the expectations of the investors, whose main endeavor is to generate greater revenue and attain a return on their investment (Securities Exchange Commission, 2012).

Risk / Reward Position to an Investor when Purchasing Stock during an IPO

When purchasing stock during an IPO, an investor can stand to gain plenty of rewards but at the same time faces a great risk. One of the key advises I would give an investor is to understand that not every IPO is detrimental. The risk lies in the assumption basically that IPOs are intrinsically good investment prospects. It is imperative to note that some IPOs are riskier compared to others and some have more potential for greater rewards than others (Hamilton, 2013). A key element to take into consideration is to analyze and fully comprehend the company's business model, its first principles and also management team. By analyzing the company's prospectus, it is possible for an investor to examine financial aspects such as financial growth and prospective earnings. This way, an investor can gauge the company's performance against its competitors and also within the industry it operates.

Another aspect that the investor ought to do is be wary and cautious. There is a lot of uncertainty that encircles IPO largely, owing to the lack of accessible information. If your broker vouches for an IPO, as an investor, one ought to exercise greater caution than before. This is an apparent sign that most institutions and money managers have courteously passed on the underwriter's endeavors to sell them shares. In this circumstance, individual investors are probably getting the scraps that major establishments did not want (Investopedia, 2015). In addition, the investor ought to consider waiting for the lock-up period to end. In delineation, the lock-up period is a lawfully binding agreement usually ranging from 2 months to two years, between the IPO underwriters and insiders of the firm, preventing them from selling any shares of the company for a particular period. Once the lock-up period ceases, then the restricted parties are allowed to sell their stock. The key element for the investor is that waiting until insiders are unrestricted to sell their shares is a good strategy, for the reason that if they carry on holding shares even after lock-up period has ended it may be a sign that the firm has an optimistic and sustainable future. In the course of the lock-up period, an investor is not able to determine whether the insiders will be content with taking the spot price of the stock or not (Investopedia, 2015).

Facebook Stock Price Prediction in the next 5 years

Thus far, the stock price of Facebook has significantly grown up by 12.45% surpassing the S&P 500 by 8.9%. In the next five years, I can predict the Facebook stock price increasing by over 100%. Without doubt, as a social media giant, Facebook continues to attract more institutional appeal as both its top lines and bottom lines increase. During the 1st quarter of 2015, Facebook grossed $0.77 per share on revenue of $5.4 billion, a result that was 10% greater than the uppermost Wall Street approximation. In addition, the company's earnings per share and revenue increased by 83% and 53% respectively. In addition, regardless of its strong growth in revenue since its IPO, the company is still relatively young with a lot of room to grow (Alter, 2016).

Two key elements will drive the company's stock up over 100% mark in the next five years. To begin with, Facebook is now a social networking company for all users. In particular, the user base of the company accounts for 1.79 billion active users every month. To begin with, taking into consideration the advancement in technology and access to internet across the world, Facebook will continue to experience strong growth as advertisers become inclined to where massive numbers of people spend their time online. In addition, Facebook is presently undervalued in relation to future growth, which indicates that the company's stock can only perform even better and outperform market expectations (Zanoni, 2016).

Secondly, as pointed out by Zuckerberg, the firm's five-year plan encompasses taking Facebook's next generation of services, Instagram, Messenger, Whatsapp and Search and facilitating them to connect billions of people, growing them into significant big business in their own right. Through these services, the company is bound to increase its revenue and growth, which in turn will have a boosting impact on the growth of the stock. In addition, it is imperative to note that presently, Facebook allowed more than 1.5 million advertisers on Facebook to spread out their campaigns across mobile platforms and for developers to start monetizing their apps. This figure is bound to significantly increase over the course of the next five years, increasing the total revenue generated by the firm by a whooping amount and boosting the performance of the stock (Shontell, 2014).