Facebook value overstated, study finds

Researchers warn of a social networking bubble in the offing

Claims that Facebook is worth $100 billion or even just $65 billion grossly overvalue the company, say researchers who have done a simple calculation of the company’s worth. The pair of econophysicists warns that inflated value estimates for sites such as Facebook, Zynga and Twitter are signs that a social networking financial bubble is gaining steam.

“It’s not the same volume of the dot-com bubble. That was really widespread,” says coauthor Didier Sornette. Nevertheless, he and colleague Peter Cauwels conclude, a social networking bubble — and its impending pop — loom.

The ETH Zürich researchers argue that determining the value of social networking sites is vastly simpler than with other companies, because there’s a relatively direct link between the number of users and profit. This boils the math down to a simple equation: the number of users times the profit per user. Calculated that way, Facebook’s value is probably in the neighborhood of $15 billion to $30 billion, the team reports online October 6 at arXiv.org.

Figuring out the number of people with Facebook accounts was easy: The company reported reaching 750 million users in July.

Figuring out how much each user is worth was a little harder. Because the company is private, the researchers had to estimate revenues and profits. Based on reports bandied about by financial industry insiders over the years, the team calculated an average profit margin of 29 percent. This yields an estimated profit per user of $1 per year.

Then the researchers plugged these numbers into some simple growth models. Assuming unlimited exponential growth quickly inflates the number of users beyond the world’s population, which isn’t very realistic.

So the team used a more moderate growth calculation that’s favored by ecologists to estimate things like rabbit population size, which would grow exponentially if it weren’t limited by real-world factors like predators and disease. This trajectory accounts for things that can be expected to slow Facebook’s growth, such as future competition or limits to the expansion of Internet access in the developing world.

That approach pegged Facebook’s value at somewhere between $15.3 billion and $32.9 billion.

The math used in the assessment is solid, says Theodore Modis, physicist and founder of Growth Dynamics, a strategic forecasting firm based in Lugano, Switzerland. “It’s a wonderfully robust result and suggests that the market value for Facebook has been grossly overestimated,” he says.

Others find the assessment too simplistic. “The math is interesting, but it’s mute about a lot of important things,” says marketing scientist Peter Fader of the University of Pennsylvania. For example, the analysis assumes that all Facebook users remain users forever. Customer retention can have a huge influence on a firm’s value, says Fader. “This paper doesn’t fully account for phenomena that we know exist,” he says.

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