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John R. Talbott

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Why Facebook Is Undervalued

Posted: 07/19/11 09:24 AM ET

Facebook shares are currently trading in private transactions that value the company at close to $80 billion. A public offering is expected next year at what some guess will be a $100 billion plus valuation. While these valuations seem high for a company that was started just seven years ago by a Harvard undergrad in his dorm room, they don't even begin to touch the potential valuation that Facebook might attain in the very near future.

As is commonly reported, Facebook has over 500 million users. To arrive at a valuation, one need only guesstimate how much revenue and profit Facebook can "earn" from each of these users and apply a reasonable multiple of earnings and/or sales to arrive at a current valuation. Cable television and cellular telephone companies do similar calculations to arrive at their market values by determining the value of each of their subscribers to their companies.

Facebook, it appears, could easily earn $20 in profit each month off of each of its subscribers through online advertising. This works out to less than a dollar a day or $240 a year in profits per subscriber for total profits for the company of $120 billion per year.

Facebook has a number of additional businesses it could offer its subscribers. Online interactive games on Facebook have become popular and could easily contribute another $10 a month in profits to Facebook or an additional $60 billion in profits each year.

Facebook could also offer a service in which subscribers lost and all alone in a new city could find a fellow subscriber in the neighborhood who might have an empty couch available thus saving the cost of a hotel room. Hotel rooms can cost $200 to $300 a night so this should add greatly to Facebook profits. Come to think of it, there is no need for subscribers to rent or buy cars in the future as GPS technology could easily locate a member close enough to give you rides to meetings and such. Such opportunities might add an additional $50 in profit per month to Facebook or additional earnings of $300 billion per year.

Facebook has been criticized for selling private information supplied by its members to advertisers, but they could easily turn this weakness into a strength by offering protection against such privacy intrusions. What would this be worth to the average subscriber, not having his or her private and personal information splashed all over the internet? If Facebook charged them $10 a month to avoid these incredibly embarrassing posts I doubt few would object thus adding an additional profit stream of $60 billion a year.

Dating sites, online classified ads, blogs and newsites, online booksellers, travel sites, coupon offers, movie downloads and even porn sites would all eventually have to move onto Facebook or face extinction. If Facebook charged them a reasonable 20% of revenue protection racket for assuring they could continue their businesses, this works out to approximately $100 billion a year in added profits to the Facebook.

So, in aggregate, Facebook could earn something like $640 billion a year in profits. Applying a conservative 35 P/E multiple to these earnings means the company is worth approximately $22.4 trillion.

But, this assumes that the number of subscribers to Facebook stays constant at 500 million. Certainly, it would not be crazy given its recent astronomical growth rate in membership to assume that very soon the Facebook will have all 6 billion people on the planet as members, especially after its launch of Babybook giving toddlers the chance to connect and share their goo-goo, gah-gahs and baby photos.

When you think about it, there is also no reason Facebook should be offered free to its members. Once the Facebook achieves total global domination it could easily charge a subscriber fee of $20 a month to its 6 billion members. This is about the same as the cost of a gym membership and most humans would find this incredibly reasonable given that by then they won't be able to eat, breathe, walk or read without Facebook's permission.

This brings the total valuation of the company to $320 trillion, and does not even count the potential growth prospects of introducing the Facebook to as yet undiscovered alien planets and civilizations. Of course, additional value will be created for the Facebook in the future by its subsidiaries offering networking sites to lesser species such as Pawbook for dogs, Catbook for felines and Chimpbook for our more distant, yet underserved relatives.

[Tomorrow, I will offer a more reasoned explanation why Facebook and other high-tech companies like Groupon, Linked-In, Google and Apple are all wildly overvalued, at least on this planet.]

John R. Talbott is a best selling author and consultant. His new book is mandatory reading for anyone interested in learning the real reasons for this crisis and how to protect yourself going forward. You can read more about John and the new book at www.stopthelying.com or at amazon.com. Information for media contacts is available at www.stopthelying.com.