Important disclosures appear on the last page of this report.

The Henry Fund

Henry B. Tippie School of Management

Gaurav Ghantkar [Gauravarvind-sinaighantkar@uiowa.edu]

Facebook Inc. (FB) April 11, 2016

Information Technology – Social Networking Stock Rating Buy

Investment Thesis Target Price $135-$151 We recommend a BUY rating for Facebook. The company is seeking the right strategy as it seeks to channelize its efforts to grow its user base and increase the time spent by users on their products. Further it has strived to periodically provide innovative features, updates and products. In this quest, they have added to their portfolio of offerings by making niche strategic acquisitions such as that of WhatsApp Inc., Instagram and Oculus. Drivers of Thesis

Advertising Revenues: Facebook is highly dependent on its advertising revenues. We have assumed a CAGR of 17% Y-O-Y in the digital advertising space as we estimate increasing trends in number of users, time spent by user and positioning/relevance of advertisements.

Monetizing WhatsApp: Post the 1 billion user mark for WhatsApp, Facebook has shown willingness to monetize the app through alternate routes than advertising. We estimate such an update to come in the year 2017.

Virtual Reality: Facebook has diversified its portfolio of offerings by foraying into Oculus Virtual Reality Products. Although, we estimate modest revenue generation through this segment, we see enormous potential in such disruptive technologies post 2020.

Risks to Thesis

Monetization: Failure to effectively monetize WhatsApp that involved a hefty $19B acquisition. There has been talk of using alternate revenue generating methods than advertisements and a lot of revenue depends on how well it monetizes the app.

Currency Headwinds: Currency pressure will remain a headwind as around 50% of revenues come from outside US and hence Facebook is susceptible to foreign currency fluctuations.

Duplicate Accounts: Duplicate accounts can cause the number of user estimates to be faulty.

Henry Fund DCF $148.53 Relative Multiple $64.76 Price Data Current Price $110.63 52wk Range $72.00 – 117.59 Consensus 1yr Target $133.64 Key Statistics Market Cap (B) $315B Shares Outstanding (M) 2847 Institutional Ownership 70.8% Five Year Beta 0.948 Dividend Yield 0.00% Est. 5yr Growth 3.5% Price/Earnings (TTM) 81.10 Price/Earnings (FY1) 32.5 Price/Sales (TTM) 16.66 Price/Book (mrq) 6.73 Profitability Operating Margin 34.72% Profit Margin 20.47.% Return on Assets (TTM) 8.19% Return on Equity (TTM) 9.14%

Earnings Estimates Year 2013 2014 2015 2016E 2017E 2018E

EPS $0.62 $1.12 $1.31 $2.08 $2.88 $4.00

growth 3000% 80.65% 16.96% 58.69% 38.47% 38.95%

12 Month Performance Company Description

Facebook Inc. is a social network company incorporated in 2004. It builds products that enable individuals to share and exchange content on mobile devices or on personal computers, thus making the world more open and connected. It went public in May 2012. It caters to a number of products including Facebook, Instagram, Messenger, WhatsApp, and Oculus. The company was founded by Mark Zuckerberg, Dustin Moskovitz and others. It is headquartered in Menlo Park, CA.

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Source: Factset

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EXECUTIVE SUMMARY

Facebook is the world’s largest social networking platform and helps connect users through a suite of website and mobile applications. The growth of Facebook has given it a lot of room to explore different avenues of business such as messaging, virtual reality and drone capable of delivering internet to remote places.

The business model of Facebook is driven chiefly through the advertisements that are displayed on its website and mobile app. In 2015, 95% of its revenues were generated through advertising. We expect the healthy advertisement cash flows to continue in the foreseeable future and have expected it to grow at a rate of 17% Y-O-Y CAGR until 2025.

The payments and other fees segment draws in around 5% of the revenue. The year 2015 saw a 12% drop in the revenues in this segment. We expect this trend to continue in the future partially offset by revenue generated by WhatsApp and Messenger in the future.

The company is heavily focused on Research and Development to furnish new updates, features, and products. Facebook showed a CAGR rate of 36% in R&D since it went public in 2012. The previous two years 2014 and 2015 accounted for a whopping 88% and 81% increase in R&D expenses respectively. This translates to an average rate of 24% of revenue for the past two years.

The company has also showed zest for making strategic acquisitions over the years, most notable among them being the acquisition of WhatsApp Inc. ($19 B), Instagram ($1B) and Oculus ($2B). Through the acquisitions it seeks to add to its user base, eliminate direct competitors, build upon its innovative product offerings and diversify into newer avenues of technology.

Facebook has periodically rolled features and updates such as Live Feed, Facebook Live that are likely to get users hooked onto the product for longer durations. We expect this trend to continue, which spells increased revenue through advertisements for the company.

We believe that the intrinsic value of the company is most closely reflected by the DCF valuation and hence, we recommend a BUY for this high growth stock.

COMPANY DESCRIPTION

Facebook Inc. is a social-networking platform provider to commercial and non-commercial customers. It permits user to share photos, videos, ideas and other content through its mobile and desktop suite of products. In recent years the scope of Facebook has been expanded to include messaging apps such as Facebook messenger and WhatsApp, and Virtual Reality products through the launch of its niche product- Oculus.

Thus Facebook caters primarily to five products- Facebook, Instagram, Messenger, WhatsApp and Oculus.

Facebook

Facebook is a mobile application and website that enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. (1)

The product hosted 1.04 billion daily active users (DAUs) as of December 2015, an increase of 17% Year-over-Year. Mobile DAUs were 934 million on average for December 2015, an increase of 25% year-over-year. (1)

As can be seen in the graph below, we are seeing trends of increasing DAU’s since the company went public in 2012. We expect the trend to continue in the foreseeable future as we believe the company is constantly seeking to innovate and roll out new features and products. Features such as Facebook Live (which will be explained later under the section- Recent Development) and Infinity Newsfeed cause us to expect the burgeoning user trend to continue and generate healthy advertising cash flows for the company.

Source: Statista

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Monthly active users (MAUs) were 1.59 billion as of December 2015, an increase of 14% year-over-year. Mobile MAUs were 1.44 billion as of December 2015, an increase of 21% year-over-year (1)

A similar trend can be seen for the Monthly active users below:

Source: Statista

As of now, Facebook product generates its revenue through two channels:

Advertising

The primary source of revenue for Facebook has been advertising through its website and mobile app. Advertising accounted for 95% of the revenue in 2015. In 2015, mobile advertising revenue represented approximately 77% of total advertising revenue, as compared with approximately 65% in 2014. (1)

The year 2015 also witnessed the average price per ad increasing by a whopping 140% while delivering a reduced number of ads. Advertisers pay either based on number of clicks made by users, number of actions taken by people, or the number of impressions delivered. (1)

We expect revenue growth at 40% in 2016 and the growth decreasing by 4% every year till 2025.This translates to a CAGR of 17% to drive the advertising revenues till 2025. This value is markedly below the 48% advertising revenue growth Facebook achieved in 2015. Such a number has been ingrained in our assumptions because the Facebook 10k explicitly mentions that the company will not be able to achieve the historical revenue growth it has achieved in

previous years. A possible reason for this is that the initial few years of the company showed explosive growth due to the enormous promise the company showed. As the company matures, we expect the revenues growth to show a decreasing trend and finally grow at a CV growth rate of 2.5%.

Payment and Other Fees

This segment accounts for payments people make to purchase virtual and digital goods from Facebook Developers. The payments can be made using debit cards, credit cards, PayPal, or other methods. (1)

This segment has accounted for a mere 5% of the revenue generated in 2015. Further, the year 2015 witnessed a decline of 12.83% in this segment owing to decreased payments for games played on personal computers. We forecast this negative trend to continue for the coming three years. We expect Facebook to monetize WhatsApp (will be explained later) by 2017 and expect the revenue from this business to offset the negative trend by a slim margin. This is assuming that Facebook choses to include any WhatsApp revenue in this segment. If Facebook choses to report a new line item in the future in the 10K for WhatsApp revenue then the above inclusion will be invalidated and included in the new line item per se.

Source: Statista

As seen in the above graph, advertising revenue accounts for a significant portion of the total revenue. As discussed above, we expect this trend to continue.

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WhatsApp

WhatsApp Messenger is a cross-platform mobile messaging app that allows a user to exchange messages. (34)

WhatsApp has been Facebook’s largest acquisition till date costing it a whopping $19 Billion in 2014. The deal involved $4B cash, $12B stock and $3B stock grants if the founders of WhatsApp remain employed with Facebook. The motivation for the deal were two fold. First to obtain access to the vast user base of WhatsApp. Second to prevent competition from gaining access to such a user base and product that could compete directly with Facebook. While the acquisition has been successful, ways to unleash the revenue generating potential of the product has not yet been fully utilized. In our opinion, the acquisition has been slightly overpriced by a 10-15% margin, considering the fact that the app is not fully monetized.

The product has been a loss leader to date for Facebook, and FB does not report its revenue separately on the 10K. We see the commitment of Facebook to avoid ads on WhatsApp as a significant step to ensure the attractiveness of the app and retention of existing users. There has been talk about alternate ways of monetizing the app by tying up with third parties such as Banks, Flight Ticket Providers and Restaurants. Our analysis indicates that 2017 would be the year when such a revenue generating update will be provided by the app. We have accommodated the revenue generating potential of WhatsApp in our model.

Source: Statista

As can be seen in the above chart, February 2016 saw the number of Monthly Active Users on the app crossing the billion mark. The achievement is significant, as the company can now focus on monetizing the app rather than focusing solely on growing user base.

Further the company has slashed the subscription prices for its app to zero and has added an end-to-end encryption feature to its product. (Explained further in the Recent Development Section).

As seen in below chart, we can see that the volume of photo and video data has shot up in 2016. Here we see a strategical significance behind some of Facebook’s recent acquisitions such as QuickFire Technologies and Masquerade Technologies Inc. that cater to video compression and editing respectively.

Source: Statista

Instagram

Instagram is a mobile application that enables people to take photos or videos, customize them with filter effects, and share them with friends and followers. (1)

The acquisition of Instagram was completed in April 2012 for $1 billion: $300 million in cash and rest in Facebook stock. The app catered to 30 million users then. Here again the rationale behind the acquisition was to eliminate a competitive app that had enormous social networking potential. The app did not generate any revenue at the time of the acquisition and started to do so in 2013.

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We believe that the acquisition has been at a bargain, considering the advertising revenue that can be generated from Instagram. Facebook does not separately report the revenue for Instagram and the revenue is included in the advertising segment. It is quite safe to assume that a significant portion of this revenue is due to Instagram. Our 40% advertising CAGR in our model accounts for the revenue generating potential of Instagram.

As can be seen in the chart below, Instagram is still catching up among the social network users in US and accounts for only 43% of the social media users in 2015, and caters to 24% of the total population. We expect the penetration rates to increase by 2020 along with a corresponding increase in ad revenue.

Source: Statista

Below, we see an increasing trend in the Monthly Average Users on Instagram. Although far from hitting the 1 billion user mark, the app has and will show enormous revenue generating potential. Further, in order to realize the synergetic benefits of the two social networks, Facebook has integrated the Instagram app into its website thus making the app more inclusive.

Source: Statista

Oculus

Oculus virtual reality technology platform allows people to enter a completely immersive and interactive environment to play games, consume content, and connect with others. (1)

The company was bought by Facebook in March 2015 for $2 billion: $400 million cash and rest in stock. This is a step away from Facebook’s core competency of social networking. A rationale for this acquisition may be the passion of the CEO, Mark Zuckerberg, for disruptive technologies. Second, this may be a prudent choice to diversify the products of the company by entering into virtual reality immersive hardware technologies. Finally, virtual reality technology, though in nascent stages of development, holds enormous potential in the future. While the scope of Oculus Rift has been restricted to gaming, it is quite evident that the technology can be extended to education, tourism, consulting, sports viewership and the like. We are seeing a time horizon beyond 2020 for this technology to pick up. We are skeptical about this product going mainstream and adopted by the masses pre 2020. We expect a CAGR of 11% year on year growth.

Facebook Messenger

Messenger is a messaging application available for mobile and web that allows user to exchange messages and engage with people. It is a stand-alone app. Facebook is constantly rolling out new features for the app such as Video Calling, Sharing of Location etc.

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There are plans of monetizing the app in the future. Probable revenue generating models that the company is looking at are booking transportation through the app, ordering goods through the app. We expect such an update to come in 2017 and expect revenue growth by +2% in 2017, and increasing 2% year on year till 2025.

Geographic Decomposition

Facebook operates in different geographies around the world. Below chart indicates a large chunk of Facebook Monthly Average users come from Asia-Pacific. However Facebook rakes in a disproportionate amount of revenue from the domestic market. The Average revenue per user (ARPU) for US and Canada is about 7 times that of an Asia Pacific user. ARPU is defined as Revenue by Geography per quarter per monthly active users. (1)

Source: 10K

Source: 10K

The worldwide ARPU in 2015 was $11.96, an increase of 27% from 2014. (1) The greatest increase in ARPU was for US and Canada aided by the strengthening of the dollar.

The weakening of international currencies lowered the ARPU for international markets.

Geography ARPU Increase 2015 over 2014

US and Canada 45%

Europe 23%

Asia Pacific 22%

Rest of the World 15%

Source: 10K

The increasing ARPU signifies the effectiveness of the advertisements as they are becoming more targeted and focused.

RECENT DEVELOPMENTS

Acquisitions

Bolstered by fat cash balances, Facebook made a series of acquisitions in 2015 and 2016 in pursuit of its strategy to seek innovative products and companies. Further it also seeks to expand its user base and attract niche talent and market leaders through these acquisitions. Most of these acquisitions have been for an undisclosed sum and thus the amount may not be mentioned below in our discussions.

Masquerade Technologies Inc.

In a bid to incorporate video editing features and services, Facebook acquired Masquerade Technologies Inc., a Belarus based start-up that lets users put filters on videos, for an undisclosed amount in March 2016. The acquisition is in line with Facebook strategy to seek innovative products and attract and retain users. The primary target segment here is teenagers and millennials, who are increasingly preferring engaging apps such as Snapchat that allow them to modify and share videos.

Our analysis indicates that, while the acquisition has been successful, Facebook has not yet integrated these features into any of these products. This may be part of a conscious effort by Facebook to release newer features periodically in order to generate renewed interest by users.

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US and Canada Europe Asia Pacific Rest of the World

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This acquisition also comes in the backdrop of a failed bid by Facebook to acquire Snapchat for $3 billion in 2013.

Tugboats Yards Inc.

In May 2015, Facebook acquired Tugboats Yards Inc., a startup that lets subscribers make payments to publishers in exchange for the subscription, for an undisclosed amount.

A plausible explanation for this acquisition is Facebook’s desire to build its capabilities in content publishing space, and to benefit from the expertise of the Tugboat’s CEO, who is expected to join Facebook as part of the deal.

QuickFire Networks Inc.

QuickFire Networks, a startup that provides a hardware and software platform to compress videos and reduce file transfer time, was acquired by Facebook in January 2015.

The acquisition perfectly complements Facebook efforts to boost viewership of videos through its website and mobile app and to support the introduction of its auto play video feature.

We believe that the acquired video compression capabilities if integrated successfully with the Facebook product will result in the same content quality being delivered at a reduced storage and hence reduced operating costs.

Pebbles Interfaces

Pebbles Interfaces, an Israeli motion sensing Technology Company in the virtual reality space has been acquired by Oculus, a Facebook product, in July 2015.

We believe that this is a clear strategy by Facebook to build its expertise in the virtual reality domain and periodically release better updates to its Oculus products so as to generate renewed market interest. Such acquisitions cause us to believe that the Oculus product sales will show an increasing trend in the future, an estimate that has been factored in our model.

Surreal Vision

Further Oculus Virtual Reality have acquired Surreal Vision, a UK based company that can recreate real world maps as virtual images.

The acquisition speaks volumes about the ambition of Facebook to move beyond virtual reality and enter the augmented reality market. We believe the technology is still in its early stages and has not been fully utilized to derive monetary benefits. Hence, we have not incorporated the Augmented Reality market into our model. But given Facebook’s commitment to Oculus and virtual reality, we are positive about Facebook venturing into the Augmented Reality space in the future.

WhatsApp Encryption

In April 2016, WhatsApp rolled out an end-to-end encryption update for its users. The update is a significant step to ensure total security/privacy over its calls, messages, and data exchange. It ensures that only the sender and receiver have access to the messages and eliminates WhatsApp employees, government, cyber criminals or any third parties from accessing the data.

We see this update as relevant to building trust in the community and in the app and thus, we expect the volume of data to increase in the foreseeable future due to the increasing faith users will now have in the app. However, we do not believe that this app will be an alternate means to carry out business data exchange, due to the social tag that has been historically associated with this app. Further, it remains to be seen how such high-end security will spell with governments across the world especially in the developing nations, who are increasingly vulnerable to security and terrorism issues.

As WhatsApp does not deliver advertisements on its app, we do not see a direct translation of the volume increase to a revenue growth. However, since WhatsApp has exceeded the 1 billion user mark, we are assuming here that WhatsApp will partner with businesses to develop a revenue generating model in the future and seek ways to monetize it. We expect such an update to come in 2017. Our model accounts for these expectations as a +2% revenue increase year-over-year in the Payment and Other Fees segment of Facebook.

WhatsApp Fee Elimination

January 2016 saw the elimination of the $1 fee that WhatsApp charged its users. The news is interesting considering the 1 billion and still growing number of users

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of WhatsApp. This clearly translates to a $1 billion lost opportunity for WhatsApp per year. However, given the fact that many of its users in international markets do not have a credit/debit card, this seems a rationale decision as it is often difficult to retrieve the subscription fee.

We believe the cutting down of fees is a prudent decision by WhatsApp seeking to retain the existing users and preventing them from switching their loyalties to other social messaging apps such as WeChat. Further, WhatsApp will be looking at newer avenues of revenue generation in the foreseeable future such as partnering with banks or restaurants that seek newer ways to enquire about transactions or delivery status.

Oculus Shipments

March 2016 saw the first shipments of the much awaited Oculus Rift, Facebook’s foray into immersive hardware virtual reality electronics. The headset costs a hefty $600 and is priced at a premium. The product however necessitates the use of a high end PC to enjoy the experience.

While we are especially positive about the direction in which Facebook is heading in the Virtual Reality domain, we are equally skeptical about the mass adoption of these products in the coming few years, especially considering the nascent stages of development that virtual reality products are in. We have approximated Oculus to cater to 30% of the Virtual Reality market share, as predicted by Statista, in our model.

The first shipments were plagued with delays. However we believe that these are minor hiccups along the way as Oculus seeks to streamline the deliveries of its products to customers.

Facebook Live Video

August 2015 saw the launch of Facebook Live- a feature that permits a user to share a moment instantly with friends, family, fans or other users. (36) This feature was restricted to public figures. However Facebook has extended this option to all users in April 2016, and has even rearranged its notification icon for its mobile app to accommodate the change.

The rationale behind this launch is to get users to spend a greater amount of time on the website or the mobile app, and in turn generate a larger advertising revenues for

Facebook. While the update may seem a minor one, we believe that the ramifications of this single update is huge and will involve users getting increasingly addicted to the product. The assumption of 40% CAGR advertising revenue growth in our model includes the revenue generating potential that can be unleased through this update.

Q4 2015 Earnings

Facebook Shares surged 13% as the earnings beat analyst expectations in January 2016. The revenue generated for the fourth quarter was $5.84B versus analyst expectations of $5.37B, up 52% year-over-year. (49)

Adjusted EPS was $0.79 up above expectations of $0.68.

The revenue growth was fueled by an increase of 21% year-over-year Monthly Active Users hitting a figure of 1.59B Users above street expectations of 1.58B. The Daily Active Users were in line with street expectations at 1.04B, an increase of 17% year-over-year. (49)

Connectivity Lab

July 2015 signaled a major milestone for Facebook in its pursuit of providing internet to remote portions of the world. The Connectivity Lab, which is the aerospace and communications research lab of Facebook, announced a full scale version of Aquila, a high altitude endurance aircraft that can circle a remote region for 90 days without landing. This is path breaking achievement for the team as it holds enormous potential to provide internet to users in inaccessible regions of the world. Further their laser communications team achieved data speeds of hundred MB per second. (50)

We see a clear translation of these achievements to a growing Facebook user base in the future and thus increasing revenues.

Free Basics

Facebook’s endeavor to provide accessible internet titled Free Basics was banned by the Telecom Regulatory Authority of India in February 2015. The goal here was to tie up with Internet Service Providers and provide sites such as Facebook and its products freely to the consumers. However, yielding to demand by consumers who reasoned that such a move would suppress competition and that every content on the internet should be treated similarly- a concept called as net neutrality.

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The repercussions of this decisions are huge. It slows down Facebook’s effort to push their products to the billion plus Indian population. We expect Facebook to seek alternate methods to bring internet and hence its products to the remote parts of India.

INDUSTRY TRENDS

Mobile Advertisements

The advertising revenue growth for Facebook in 2015 was primarily driven by Mobile ads on News Feed. Mobile advertising revenue accounted for 77% of total revenue as compared to 65% in 2014. (1)

Source: 10K

We expect the year 2021 to see the mobile advertisement revenue by Facebook reach a whopping $70B, up from $17.9B in 2015. We are seeing clear trends of mobile advertisements picking up in the future. Features such as incorporating the advertisements in the news feed and infinite news feed are steps taken by Facebook to overcome the limited screen size of smartphones and they have been successful in the endeavor. Further, through the user of clever analytics they have been able to make the advertisements more specific and consumer focused.

Source: Statista

Live streaming

Bolstered by faster internet speeds, Wi-Fi and 4G networks, consumers are getting increasingly inclined towards watching real-time videos. The viewership of videos especially live videos has gone up in recent months. Live Streaming is expected to be the next big thing in social networking. The fact that videos can be monetized more easily than perhaps messaging makes it an attractive proposition for social networking firms. Facebook and Twitter have already made their first moves in this direction. Facebook recently made available Facebook Live, which allows rendering of live data feeds, to the public. Earlier this was restricted only to public figures. Further this is a strategic choice by them to counter Twitter that acquired Periscope. Periscope is a live video streaming app that allows a user to watch and broadcast live videos from all over the world. A similar app named Meerkat has been launched by a smaller company called Life on Air Inc.

Virtual/Augmented Reality

Virtual Reality involves complete simulation of a user’s environment through the means of a Head Mounted Device (HMD). In augmented reality the user sees the real world but with additional computer generated images. (47)

While we are skeptical about the mass adoption of these devices in 2016, we are positive that we will see adoption of these devices post 2020. We are seeing clear trends by companies trying to build their capabilities and expertise in such immersive technologies. The major players in this

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industry are explained later in the section “Markets and Competition”.

MARKETS AND COMPETITION

Facebook competes in markets that are characterized by large user bases, constant innovation, quick obsolescence and highly disruptive technologies.

The major players in this market are Google, Microsoft, Apple, Yahoo, Twitter, Snapchat and Linked In in the domestic market. It also face competition from Chinese companies such as Tencent and Baidu.

Social Networking and Messaging

The social networking market is very competitive and the primary players in the industry compete for user bases and advertising revenue. Companies such as Twitter (Micro Blogging), Facebook (Social Networking), LinkedIn (Professional Networking) or Google (Social Networking, Video Streaming) are highly differentiated and hence can often cater to overlapping set of user bases. The barriers to entry in this industry are relatively low and requires a niche and differentiated idea. However, sustenance of such a business or monetization of the idea is difficult, and companies find it challenging to compete with the bigger players who have large cash balances, better human resource talent and larger research and development expenditures. In the past highly reputed companies such as Orkut have found themselves driven to obsolescence by newer ideas and by a lack of innovation. We have also witnessed major players engaged in hostile competition with each other, trying to enter the core turf of the rival. We saw this happening as Google Plus made strong attempts to dislodge Facebook as an alternate social networking platform but eventually could not do so.

As can be seen in below chart, Facebook maintains a market leadership among the social-networking companies with four of its products- Facebook, Messenger, WhatsApp and Instagram in the top ten active user rankings. However, the products carry the risk of cannibalization of advertising revenue as they compete for same user basis and viewership.

Source: Statista

As can be seen in the below chart, Facebook sees the relevance of video in social networking and are looking to fend off YouTube which caters to a healthy 22.2% of the total number of social media website visits. Newer updates such as Facebook Live, and acquisitions such as of Masquerade Technologies are attempts to beef up the video capabilities of the website.

Source: Statista

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Virtual Reality

Virtual Reality involves the use of immersive hardware electronics, software and virtual content to completely simulate 3 dimensional view of user’s environment. (41)

The major players in this industry are Facebook’s Oculus Rift, Sony Corporation’s Project Morpheus, HTC Corporation (Taiwan) and Valve Corporation US are jointly developing HTC Vive. (41) Sony’s PlayStation VR is to be launched in Oct of this year and is priced below Oculus Rift, while HTC Vive is priced at $800 above the Oculus price tag. It also faces competition from Google Glass that caters to augmented reality and is differentiated from VR products. Microsoft’s HoloLens is a product in the virtual/augmented reality category.

Product Selling Price

Oculus Rift $600

Sony PlayStation VR $500

HTC Vive $800

Microsoft HoloLens $3,000

Source: Oculus, Microsoft, Sony, HTC VIVE website

The virtual reality market is a characterized by disruptive technologies. As can be seen below, the virtual reality market is relatively new phenomenon in the nascent stages of development and caters to a small overall market. We have used the Early Adopters category in our model. Early Adopters are users who will take up this technology in the early stages of its commercial use. In the absence of clear data signaling market leadership among the above competitive products, we have given an equal weightage of 20% market share to each product in our assumptions. This translates to a revenue stream of $684 M, $1044M, and $1428M in 2016, 2017, 2018 and a growth rate of 52% and 36% for Oculus Rift.

Source: Statista

Peer Comparisons

For comparison purpose, here we will use peers of Facebook that are technology companies focused on innovation and that cater to large user base. Each of these companies have their unique core competencies that involve differentiating business model. Often the user base among these companies overlap significantly. Twitter Inc. is a microblogging site. LinkedIn caters to professional connecting website. Google caters primarily to search and email features, while Google Plus caters to social networking. Yahoo competes in the email, search, and finance data segments. However, all these companies compete with each other for advertising revenues and for users.

Alphabet Inc. and Microsoft Corporation are the biggest players in the industry. Facebook competes with the Google Plus, Google search and Microsoft Bing for advertising revenue. Twitter and LinkedIn are the relatively smaller players who have negative earnings as they have not fully monetized their business models.

Company

Market Cap Revenue EPS P/E

Facebook Inc. 340.44B 17928 1.29 81.1

Twitter Inc. 11.06B 2218 -1.14 -

Alphabet Inc. 529.78B 73590 23.12 34.09

Microsoft Corporation 439.52B 92972 2.38 29.83

LinkedIn Corporation 15.27B 2990.9 -0.99 -

Source: Factset

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As can be seen below, Facebook has among the highest Profitability Ratios in the industry only exceeded by Alphabet Inc. The higher profitability ratios for Alphabet Inc. seems justified given its strong presence in search, videos (YouTube). Further being a more mature company they have effectively found ways to monetize their operations over time. We can expect Facebook Inc. to improve upon these metrics in the future as they seek to monetize WhatsApp and Messenger apps.

Source: Factset

Facebook has some of the best liquidity ratios in the industry. This may be a conscious effort by Facebook to keep cash balances to furnish acquisitions in the future. Historically they have acquired companies in cash and stock deals. Strong Liquidity ratios give them ease and speed to move into making acquisitions.

Liquidity Ratios

Company

Current Ratio

Quick Ratio

Cash Ratio

Facebook Inc. 11.25 11.25 9.58

Twitter Inc. 8.66 8.66 6.91

Alphabet Inc. 4.67 4.67 3.78

Microsoft Corporation 2.5 2.44 1.94

LinkedIn Corporation 3.24 3.24 2.63

Source: Factset

ECONOMIC OUTLOOK

Interest Rates

December 15th witnessed the first rate hike by the Federal Reserve in nearly a decade. While the Fed has left the door open for further rates hikes, the low inflation levels are bound to impede further rate hikes, as the Fed aims for an inflation level of 2%. Further policy measures such as quantitative easing have been undertaken by the European Central Bank as they aim to boost growth in Europe. Following the trail of certain Central Banks in Europe, the Bank of Japan recently adopted negative interest rate in a move to spur growth and ingest liquidity in the aging Japanese economy.

We forecast the fed funds rate to remain at 0.50% over the 6 months horizon, while we estimate it to reach 1.25% over the next two years. The Fed fund rate hikes are bound to increase the borrowing costs and thus affect Facebook as businesses around US will find themselves with lesser liquidity to invest in advertising. We have factored the increased borrowing costs into our model while assuming a CAGR of 17% Y-O-Y growth. This rate is markedly below the 48% growth Facebook witnessed in 2015.

Strengthening Dollar

A slowdown in China coupled with the recent rate hikes, makes the dollar an attractive currency as investors around the world look upon the dollar as a safe haven. Also the weakness in European markets and the migrant crisis has further exacerbated the flight to the dollar, which is increasingly perceived as a stable currency.

Over the next 6 months the EUR/USD is expected to be $1.08. Our 2-year long-term outlook sees the Euro weakening against the dollar to $1.03.

Facebook has suffered currency losses of $66 million, $87 million and $14 million in 2015, 2014 and 2013. (1) The company currently does not hedge against currency and hence currency fluctuations are likely to remain a headwind.

GDP growth US

With real GDP growth for 4Q2015 at 1.4% (40), the Henry Fund research teams’ short-term forecast (6 month) for US Real GDP growth is 2.27%. Our long-term forecast (2 year)

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100

Profitability Ratios

ROE ROA Gross Margin Net Margin

Page 13

expects growth to increase to 2.84% by 2018. A slower US GDP growth will spell a decreased budget for advertising by US enterprises and thus will lower the advertising revenue for Facebook

Source: Bureau of Economic Analysis (40)

Global GDP growth

The World Bank forecasts the Global GDP to grow at 2.9%, 3.1% and 3.1% in 2016, 2017 and 2018 respectively. (37)We have assumed a 2.5% GDP growth to continue beyond 2025 and have grown the CV NOPLAT in our model at this rate as Facebook operates equally in domestic and international markets. Since our model is extremely sensitive to this assumption that has a lower threshold of 0.5% to break even with the current price. This choice is justified considering the fact that if the global economy slows down post 2025 then it is likely that businesses will spend lesser dollars on advertising and thus negatively impact Facebook in the long run.

CATALYSTS FOR GROWTH

• Faster roll-out of new features for WhatsApp and Facebook Messenger can result in the two apps being monetized quickly.

• Greater internet penetration rates in developing nations and international markets can result in an increase of user base for Facebook products.

•Greater time spent by individuals using the products can cause larger advertising revenues. Facebook is attempting to achieve this through features such as Infinite News Feed and Facebook Live.

INVESTMENT POSITIVES

•The Facebook trademark and brand is one of the most well recognized logo of our generation. Forbes places it at a strong 10th rank among the worlds most recognized brands in the world in 2015. (38)This brand recognition equates to the company’s ability to charge a premium for its products. Since a majority of its revenue comes from advertising, a strong brand is key to businesses being attracted to the Facebook Channel to market their products. Further, the ubiquitous global brand can be leveraged for any newer product launches.

• A strong user base catering to a whopping 1.04 Daily Active Users and 1.59 billion Monthly Active users as of December 2015. With launches such as Facebook Live and infinity news feed, the company has been seeking to find ways to get users to spend increasing time on the product.

This directly translates to increasing healthy advertising revenues and top line growth.

• First Shipments of their Oculus Virtual Reality products will add to the top line growth. The company has a head start by being among the first in the virtual reality market. While the products are not estimated to be mass adopted, this is certainly a step in the right direction as immersive electronics holds enormous promise and is likely to be the norm in the future.

• The slashing of WhatsApp subscription fees to zero and announcement of End-to-End encryption spells significant efforts by the team to increase likeability, adoption of the product and retention of users. As the number of users have exceeded the billion mark, there has been speak about ways to monetize WhatsApp through non advertising channels. We expect such an update in 2017 that will add to the top line growth.

• Facebook is also looking at means to monetize its messenger app. Possible steps of monetization have included peer to peer transfer of money by users of messenger. In a select few locations, it has launched “Transportation” on Messenger that allows users to book a cab through the app. Further by integrating video calling and allowing users to express themselves through customized conversations filled with emojis, the team are seeking ways to increase the time spent by users on the app.

Page 14

INVESTMENT NEGATIVES

•Currency pressure will remain a major headwind as roughly 50% of revenues come from outside US and hence Facebook is susceptible to foreign currency fluctuations. Further the company does not hedge against foreign exchange.

• If the routes of monetization of WhatsApp does not take off it could negatively impact the top line. Similarly if the Facebook Messenger monetization does not work out it could negatively impact the revenue estimates.

•The company primarily relies on advertising as means of revenue. Any increase in fed funds rate will increase borrowing costs and decrease advertising spending negatively impacting the top line growth.

VALUATION

The valuation of Facebook Inc. was carried out using DCF

and Relative P/E valuation techniques. The two

approaches presented a price of $148.53 and $64.79

respectively. We believe the stock value is most closely

captured by the DCF valuation and hence we have given a

BUY rating to the stock. The stock currently trades for

around $114.23 and thus we estimate an upside of 30%

that can be captured in the long run.

In our analysis, we have not used DDM valuation method

as Facebook does not pay dividend and is not expected to

pay in the foreseeable future. The company has a

commitment to retain future earnings in order to finance

the operation and expansion of its business.

In carrying out Relative P/E valuation we chose technology

companies such as Google, Twitter and Linked In that have

historically been innovative growth companies, that have

large market capitalization and those that have catered to

large user bases. We are cognizant of the fact that the

closest competitor of Facebook on a head on basis is

Google Plus, but our research tells us that Google Plus

caters to a relatively lesser volume of users and even lesser

number of daily active users. Thus, we understand that the

peers chosen have different business models and revenue

generation segments and are not strictly competitors of

each other. We expect Facebook to trade at a premium as

it is a high growth company that is not as mature (gone

public in 2012) as its peers, coupled with large

monetization expectations of WhatsApp and Messenger

that are likely to add to healthy cash-flows. Hence, we

chose to disregard the Relative valuation model.

The DCF valuation is based on the revenue decomposition

of different areas of business. Facebook generates most of

its revenue from digital advertising. We see a trend of

healthy but slower growth in the foreseeable future, as

compared to the trend for past 3 years, in the digital

advertising space. In 2015, digital advertising accounted

for 95% of the company’s revenues. The cost per

advertisement is a function of three parameters- Number

of Users, Time spent per user, positioning/relevance of the

advertisement. Features such as infinity feed, Facebook

Live and acquisitions such as Masquerade Technologies

cause us to believe that the time spent per user is going to

shoot up in the foreseeable future as users will get

increasingly addicted to the product. The clever masking

of the advertisements in between the updates in the News

Feed is a significant step to improve the positioning and

relevance of ads. Further Facebook utilizes analytics to

mine your browser history to place relevant ads. Also the

number of users on Facebook are showing increasing

trends. These three parameters compel us to be optimistic

of a healthy growth. We expect a growth rate of 40% in

2016 and the growth decreasing 4% every year till 2025.

This translates to a CAGR rate of 17% year on year growth.

The second source that accounts for approximately 5% of

the revenue is the payments that users make to purchase

digital and virtual goods from the developers. These goods

are primarily games available on the Facebook portal. The

year 2015 saw a whopping drop of 12% in revenues in this

segment. We expect the negative growth in this segment

to continue in the foreseeable future and hence we have

grown the revenue in this segment through historical

average of the past three years. Considering the steps that

WhatsApp has taken such as slashing of subscription fees

to zero and providing end-to-end encryption, we are

positive about their commitment to monetization of the

app and we expect such an update to come in 2017. We

have partially offset the negative trend by +1% in 2017 and

Page 15

increasing 1% year-on-year in this segment due to the

revenue generation expectation of WhatsApp.

In March 2016, Facebook launched Oculus Rift, its product

in the virtual reality space. We expect Oculus to have a

market share of 20% of the Virtual Reality Market. We

have used Statista estimate of 5.7, 8.7 and 11.9 Million

headset sale for the virtual reality market in 2016, 2017

and 2018 respectively. Oculus Rift sells for an average price

of $600. This translates to a revenue of $0.6 billion, $1.04

and $1.42B in 2016, 2017 and 2018. Here we also assume

that the fixed costs of the product is accounted for in the

10K, but not included as a separate line item. Our present

estimates indicate that Oculus will contribute modestly in

the next five years to the top line and thus move the

intrinsic share value of the company by a slim margin.

The company is heavily invested in Research and

Development accounting for roughly 24% of Net Sales. We

have used averages of the past 2 years to forecast future

R & D expenses as we believe these two years more closely

reflects the maturity of the company, post the major

acquisitions. Similarly we have forecasted the SG&A

expenses to reflect the last two years.

Capital Expenditures: In regards to the capital

expenditures, we have grown the property, plant and

equipment at the past three year’s historical averages.

Risk Premium: We believe that a 5% risk premium

adequately captures the risk associated with the market

over and above the risk free rate.

Beta: We set the beta to 0.948 as per the estimate

available on Bloomberg. This value reflects the historical

deviation of the Facebook stock in relation to the market.

CV growth of NOPLAT: The World Bank forecasts the

global GDP to grow at 3.1% in 2018. (37) We assume a

slower growth of 2.5% beyond 2025, when we expect the

business to stabilize. Since Facebook generates roughly

50% revenue domestically and 50% internationally, we

feel that growing the company at the global gdp level will

be a rationale choice. Hence we approximate the long

term growth rate at 2.5%. Further since the price of the

stock is extremely sensitive to the CV growth rate, we have

conducted a sensitivity analysis. We see that at 0.5% CV

growth rate, the price breaks even and there is a 0%

upside. Our model thus assumes that the company will

exceed the 0.5% growth rate in the long run.

The analysts that currently cover Facebook have presented a consensus target price of 133.64 and have a price range of $71 to $170. The median price is around 140. Our target price is in line with analyst expectations. To achieve a price range we have conducted various sensitivity analysis by minutely varying parameters such as Beta, Risk Premium, Continuing value of NOPLAT growth and WACC.

We feel that the price is justified considering the strong advertising revenues the company has drawn in in the past and will do so in future. Further additional features and updates are likely to increase the time spent by users on the product, thus generating healthier advertising streams. In this task, the expertise and technology of the acquired companies are likely to play a major part. We also believe that with time, the company will seek to improve the algorithm to place more relevant and specific ads. The company also seeks to diversify its offerings as it forays into immersive hardware virtual reality products. The diversification is likely to reduce the non-systematic risk, facing the company as historically it has solely relied on social networking as means of revenue.

KEYS TO MONITOR

Q1 2016 Earnings: The 2016 Quarter 1 Earnings will be announced on April 27th. This is a key metric to monitor in this month, especially to see if Facebook has beat the top line and EPS expectations.

WhatsApp monetization: There has been no clear disclosure about the route to monetize the WhatsApp application. While there has been a general speak about taking a non-advertisement route, perhaps by tying up with businesses to execute transactions. Any such news should be heeded carefully due to its impact on our model and assumptions. In the eventuality that such a news is disclosed, the updated estimates should be plugged into our model.

Separation of Line Items: Currently Facebook does not disclose WhatsApp, Instagram revenues separately in its 10K. Separation of line items in future should be watched

Page 16

out for as it would give us a greater clarity about the growth of individual segments of business.

Metrics: Any news pertaining to certain metrics or trends such as the average time spent by users on Facebook, the content they share, their adoption of newer features such as Facebook Live should be given careful attention, as such metrics are directly tied in to our advertisement assumptions that account for majority of Facebook revenue.

Adoption of Oculus: While the first shipments of Oculus have been delivered to consumers, the likeability of the product by consumers should be given due attention.

Rival Product Releases: Facebook operates in a technologically competitive environment, where in a single good product or idea can overnight drive an older product to obsolescence. Any news pertaining to updates/features/product launches by rivals such as Twitter, Alphabet Inc., Apple, Snap Chat should be studied and its ramifications on Facebook business model needs to be accounted for.

Macroeconomic Factors: Key macro factors such as Fed funds rate should be watched out for. There has been speak about increasing fed funds rate in the past. In the eventuality that the rate is increased, the borrowing costs for businesses will rise, leading them to spending a lesser portion of their expenses on advertising. This could negatively impact Facebook top line.

Foreign Currency Fluctuations: Facebook operates as a global product with 50% of its revenues coming from international markets. Currency fluctuations remain a headwind to the business and any strengthening of the dollar with respect to international currencies will lead to a lesser valuation of the revenues.

F8 Conference: Facebook Annual Global Developer conference will be held on April 12 and 13th of this month.

REFERENCES

1. Company 10k 2. Fact Set 3. Yahoo Finance 4. IBIS World 5. Bloomberg

6. Statista 7. Gartner 8. Mergent 9. S & P IQ 10. Reuters

http://www.reuters.com/finance/stocks/companyProfile?rpc=66&symbol=FB.O

11. NY Times http://www.nytimes.com/2016/01/28/technology/facebook-earnings-zuckerberg.html?_r=0

12. Reuters: http://www.reuters.com/article/us-facebook-results-idUSKCN0ST2VF20151105

13. http://www.zacks.com/stock/news/212260/facebooks-fb-shipment-of-oculus-rift-hits-roadblock?cid=CS-SEEKAPH-FT-212260&source=sa

14. Entrepreneur.com https://www.entrepreneur.com/article/272265

15. Bloomberg http://www.bloomberg.com/news/articles/2016-03-09/facebook-buys-masquerade-to-compete-with-snapchat-s-silly-faces

16. NY Daily News http://www.nydailynews.com/news/national/facebook-buys-msqrd-app-snapchat-like-selfie-filters-article-1.2559082

17. Reuters http://www.reuters.com/article/us-masquerade-m-a-facebook-idUSKCN0WB2RP

18. LATimes http://www.latimes.com/business/technology/la-fi-tn-facebook-masquerade-20160309-snap-story.html

19. Business Insider http://www.businessinsider.com/facebook-continues-its-mission-to-dominate-news-on-the-web-with-an-acquisition-2015-5

20. PC World http://www.pcworld.com/article/2867092/facebook-buys-video-tech-startup-quickfire-networks.html

21. Wall Street Journal http://blogs.wsj.com/digits/2015/01/08/facebook-acquires-video-compression-startup-quickfire/

22. Wall Street Journal http://blogs.wsj.com/digits/2015/07/16/facebook-to-pay-about-60-million-for-gesture-control-firm-pebbles/

23. Verge http://www.theverge.com/2015/5/26/8662107/oculus-acquires-surreal-vision-computer-vision-company

Page 17

24. Fortune.com http://fortune.com/2015/06/01/oculus-surreal-vision-acquisition/

25. Wired.com

http://www.wired.com/2016/04/forget-apple-vs-fbi-whatsapp-just-switched-encryption-billion-people/

26. WhatsApp official Blog https://blog.whatsapp.com/10000618/end-to-end-encryption

27. Independent http://www.independent.co.uk/life-style/gadgets-and-tech/news/whatsapp-update-encryption-end-to-end-messages-security-government-privacy-a6970101.html

28. Telegraph http://www.telegraph.co.uk/technology/2016/04/05/whatsapp-encryption-what-is-it-and-what-does-it-mean-for-you/

29. Guardian https://www.theguardian.com/technology/2016/jan/18/whatsapp-drops-subscription-fee-free

30. WhatsApp Official Blog https://blog.whatsapp.com/615/Making-WhatsApp-free-and-more-useful

31. Guardian https://www.theguardian.com/technology/2016/mar/28/oculus-rift-virtual-reality-headsets-shipped-facebook

32. Facebook Newsroom http://newsroom.fb.com/news/2016/04/introducing-new-ways-to-create-share-and-discover-live-video-on-facebook/

33. Time http://time.com/4285714/facebook-live-video-streaming-livestreaming-broadcast/

34. WhatsApp Official Page https://www.whatsapp.com/

35. Facebook Newsroom http://newsroom.fb.com/news/2014/03/facebook-to-acquire-oculus/

36. IMF http://www.imf.org/external/pubs/ft/weo/2016/update/01/

37. World Bank http://www.worldbank.org/en/publication/global-economic-prospects

38. Forbes http://www.forbes.com/powerful-brands/

39. CNBC http://www.cnbc.com/2016/01/29/fed-funds-futures-pricing-no-rate-hikes-in-2016-cme-data.html

40. BEA http://www.bea.gov/newsreleases/national/gdp/gdp_glance.htm

41. http://www.marketsandmarkets.com/PressReleases/ar-market.asp

42. Microsoft site https://www.microsoft.com/microsoft-hololens/en-us/development-edition

43. HTC VIVE https://www.htcvive.com/us/product/

44. PlayStation https://www.playstation.com/en-us/explore/playstation-vr/

45. Oculus Website https://www.oculus.com/en-us/blog/oculus-rift-pre-orders-now-open-first-shipments-march-28/

46. Twitter Blog https://blog.twitter.com/2016/periscope-broadcasts-live-on-twitter

47. http://www.vrs.org.uk/augmented-reality/how-it-works.html

48. CNBC http://www.cnbc.com/2016/01/27/facebook-q4-earnings.html

49. Business Insider http://www.businessinsider.com/facebook-2015-q4-earnings-2016-1

50. Facebook Newsroom http://newsroom.fb.com/news/2015/07/new-milestones-in-connectivity-labs-aircraft-and-laser-programs/

51. Facebook Developers https://developers.facebook.com/docs/internet-org

52. http://www.engadget.com/2016/02/08/india-bans-zero-rating-internet-schemes/

53. CNN http://money.cnn.com/2014/02/19/technology/social/facebook-whatsapp/

IMPORTANT DISCLAIMER

Henry Fund reports are created by student enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management. These reports are intended to provide potential employers

Page 18

and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.

Facebook Inc.

Revenue Decomposition

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Total Net Revenue 7872 12466 17928 25397 34337 45115 57209 70489 84229 97446 108988 117676 122491

% Change Y-Y 54.69% 58.36% 43.82% 41.66% 35.20% 31.39% 26.81% 23.21% 19.49% 15.69% 11.84% 7.97% 4.09%

Advertising 6986 11492 17079 23911 32518 42924 54943 68129 81755 94836 106217 114714 119302

% Change Y-Y 63.26% 64.50% 48.62% 40.00% 36.00% 32.00% 28.00% 24.00% 20.00% 16.00% 12.00% 8.00% 4.00%

Payment and Other Fees 886 974 849 802 774 763 766 786 821 874 949 1048 1179

% Change Y-Y 9.38% 9.93% ‐12.83% ‐5.50% ‐3.50% ‐1.50% 0.50% 2.50% 4.50% 6.50% 8.50% 10.50% 12.50%

Oculus 0 0 0 684 1044 1428 1499 1574 1653 1736 1823 1914 2009

% Change Y-Y 52.63% 36.78% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%

Geographic Distribution

United States 3613 5649 8513 12060 16305 21423 27165 33471 39996 46272 51752 55878 58164

% Change Y-Y 40.15% 56.35% 50.70% 41.66% 35.20% 31.39% 26.81% 23.21% 19.49% 15.69% 11.84% 7.97% 4.09%

Rest of the World 4259 6817 9415 13337 18032 23692 30044 37018 44234 51175 57236 61798 64327

% Change Y-Y 69.61% 60.06% 38.11% 41.66% 35.20% 31.39% 26.81% 23.21% 19.49% 15.69% 11.84% 7.97% 4.09%

Percentage of Revenue

Advertising 88.74% 92.19% 95.26% 94.15% 94.70% 95.14% 96.04% 96.65% 97.06% 97.32% 97.46% 97.48% 97.40%

Payment and Other Fees 11.26% 7.81% 4.74% 3.16% 2.25% 1.69% 1.34% 1.11% 0.97% 0.90% 0.87% 0.89% 0.96%

Facebook Inc.

Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Revenue 7872 12466 17928 25397 34337 45115 57209 70489 84229 97446 108988 117676 122491

Cost of revenue 1875 2153 2867 4224 5711 7503 9515 11723 14008 16207 18126 19571 20372

Research & development expense 1415 2666 4816 6127 8284 10884 13801 17005 20320 23509 26293 28389 29550

Marketing & sales expense 997 1680 2725 3641 4923 6469 8203 10107 12077 13972 15627 16873 17563

General & administrative expense 781 973 1295 1908 2580 3390 4299 5297 6329 7322 8190 8842 9204

Cost of Oculus 0 0 0 479 731 1000 1050 1102 1157 1215 1276 1340 1407

Total cost & expenses 5068 7472 11703 16379 22228 29245 36867 45234 53892 62225 69511 75014 78096

Income from operations 2804 4994 6225 9018 12108 15870 20342 25255 30338 35222 39476 42661 44395

Interest expense 56 23 23 40 54 71 89 110 132 152 170 184 192

Interest income 19 27 52 63 86 112 143 176 210 243 272 293 305

Foreign currency exchange gains (losses), net ‐14 ‐87 ‐66 0 0 0 0 0 0 0 0 0 0

Other income (expense) 1 ‐1 6 0 0 0 0 0 0 0 0 0 0

Other income (expense), net 6 0 0 0 0 0 0 0 0 0 0 0 0

Other income (expense), net ‐ ‐ 0 0 0 0 0 0 0 0 0 0 0

Income before provision for income taxes 2754 4910 6194 9041 12140 15912 20395 25321 30416 35312 39578 42771 44509

Provision for income taxes 1254 1970 2506 3264 4383 5744 7363 9141 10980 12748 14288 15440 16068

Net income 1500 2940 3688 5777 7758 10167 13032 16180 19436 22565 25290 27330 28441

Year end shares outstanding 2546.5841 2796.9052 2845 2847 2850 2852 2854 2854 2854 2854 2854 2854 2854

Net earnings per class A & B share - basic 0.62 1.12 1.31 $2.03 $2.72 $3.57 $4.57 $5.67 $6.81 $7.91 $8.86 $9.58 $9.96

Facebook Inc.

Balance Sheet

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Cash & cash equivalents 3323 4315 4907 10612 18494 28366 40676 55648 73301 93346 115178 137869 160189

Marketable securities 8126 6884 13527 13612 13698 13784 13871 13959 14046 14135 14224 14314 14404

Accounts receivable, gross 1147 1717 2627 3696 4996 6565 8325 10257 12256 14180 15859 17123 17824

Less: allowance for doubtful accounts 38 39 68 105 142 186 236 291 348 403 450 486 506

Accounts receivable, net 1109 1678 2559 3591 4855 6378 8088 9966 11908 13777 15409 16637 17318

Income tax refundable 51 0 0 0 0 0 0 0 0 0 0 0 0

Prepaid expenses & other current assets 461 793 659 1597 2159 2836 3597 4432 5296 6127 6852 7398 7701

Total current assets 13070 13670 21652 29412 39205 51366 66232 84004 104551 127384 151663 176218 199612

Property & equipment, gross 4142 5784 7819 9663 11943 14760 18242 22545 27863 34436 42559 52599 65006

Less accumulated depreciation 1260 1817 2132 3420 4834 6445 8328 10574 13286 16588 20631 25598 31714

Property & equipment, net 2882 3967 5687 6243 7109 8316 9914 11971 14578 17848 21928 27001 33292

Intangible assets, net 0 3929 3246 2435 1924 1610 1423 1320 1273 1264 1279 1312 1357

Goodwill ‐ 17981 18026 18026 18026 18026 18026 18026 18026 18026 18026 18026 18026

Goodwill & intangible assets, net 1722 ‐ 0 0 0 0 0 0 0 0 0 0 0

Other assets 221 637 796 796 796 796 796 796 796 796 796 796 796

Total assets 17895 40184 49407 56912 67060 80113 96390 116118 139224 165318 193693 223353 253084

Accounts payable 87 176 196 310 420 551 699 861 1029 1191 1332 1438 1497

Partners payable 181 202 217 537 725 953 1209 1489 1780 2059 2303 2486 2588

Accrued expenses & other current liabilities 555 866 1449 1949 2635 3462 4390 5409 6463 7478 8363 9030 9399

Deferred revenue & deposits 38 66 56 122 164 216 274 337 403 466 522 563 586

Current portion of capital lease obligations 239 114 7 11 11 12 13 15 16 11 0 0 0

Total current liabilities 1100 1424 1925 2928 3955 5195 6585 8112 9691 11205 12519 13517 14070

Capital lease obligations, less current portion 237 119 107 91 76 60 44 27 11 0 0 0 0

Long-term debt 0 0 0 0 0 0 0 0 0 0 0 0 0

Income tax payable 886 1190 2458 2922 3950 5190 6581 8109 9690 11210 12538 13537 14091

Deferred tax liabilities 0 987 163 231 312 410 520 641 766 886 991 1070 1114

Contingent consideration liability ‐ ‐ 267 378 511 672 852 1050 1254 1451 1623 1753 1824

Other liabilities,net 202 368 269 350 470 617 790 981 1179 1368 1534 1657 1725

Total liabilities 2425 4088 5189 6900 9275 12143 15372 18920 22591 26120 29205 31534 32824

Convertible preferred stock ‐ ‐ ‐ 0 0 0 0 0 0 0 0 0 0

Additional paid-in capital 12297 30225 34886 34902 34919 34935 34951 34951 34951 34951 34951 34951 34951

Accumulated other comprehensive income (loss) 14 ‐228 ‐455 ‐455 ‐455 ‐455 ‐455 ‐455 ‐455 ‐455 ‐455 ‐455 ‐455

Retained earnings 3159 6099 9787 15564 23322 33489 46522 62701 82137 104702 129992 157322 185763

Total stockholders' equity 15470 36096 44218 50012 57786 67969 81018 97198 116634 139198 164488 191819 220260

Total Liabilities and Stockholders equity 17895 40184 49407 56912 67060 80113 96390 116118 139224 165318 193693 223353 253084

Facebook Inc.

Cash Flow Statement

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Net income 5777 7758 10167 13032 16180 19436 22565 25290 27330 28441

Add: Depreciation 1288 1414 1610 1884 2246 2712 3302 4043 4967 6116

Add: Amortization 1136 852 674 563 498 462 446 442 448 459

Accounts Receivable, net ‐1032 ‐1264 ‐1524 ‐1710 ‐1878 ‐1943 ‐1869 ‐1632 ‐1228 ‐681

Income tax refundable 0 0 0 0 0 0 0 0 0 0

Prepaid expenses & other current assets ‐938 ‐562 ‐678 ‐760 ‐835 ‐864 ‐831 ‐726 ‐546 ‐303

Other assets 0 0 0 0 0 0 0 0 0 0

Accounts payable 114 109 132 148 162 168 161 141 106 59

Partners payable 320 189 228 256 281 290 279 244 184 102

Accrued expenses & other current liabilities 500 686 827 928 1019 1054 1014 886 667 370

Deferred revenue & deposits 66 43 52 58 64 66 63 55 42 23

Income tax payable 464 1028 1240 1391 1528 1581 1520 1328 999 554

Deferred tax liabilities 68 81 98 110 121 125 120 105 79 44

Other liabilities,net 81 120 146 174 191 197 190 165 124 67

Net cash flows from operating activities 7844 10455 12972 16073 19576 23284 26961 30342 33171 35251

Intangible assets, Gross ‐325 ‐342 ‐359 ‐377 ‐395 ‐415 ‐436 ‐458 ‐481 ‐505

Marketable securities ‐85 ‐86 ‐86 ‐87 ‐87 ‐88 ‐88 ‐89 ‐90 ‐90

Property & equipment, Gross ‐1844 ‐2280 ‐2817 ‐3482 ‐4303 ‐5318 ‐6573 ‐8123 ‐10039 ‐12408

Goodwill 0 0 0 0 0 0 0 0 0 0

Contingent consideration liability 111 133 161 180 198 205 197 172 129 72

Net cash flows from investing activities ‐2144 ‐2574 ‐3102 ‐3765 ‐4588 ‐5617 ‐6900 ‐8498 ‐10480 ‐12931

Additional paid-in capital 16 16 16 16 0 0 0 0 0 0

Current portion of capital lease obligations 4 0 2 1 2 1 ‐5 ‐11 0 0

Capital lease obligations, less current portion ‐16 ‐15 ‐16 ‐16 ‐17 ‐16 ‐11 0 0 0

Long-term debt 0 0 0 0 0 0 0 0 0 0

Net cash flows from financing activities 4 1 2 1 ‐15 ‐15 ‐16 ‐11 0 0

Cash Flow from all activities: 5705 7882 9872 12309 14972 17653 20045 21833 22691 22320

Net increase in cash & cash equivalents

Cash & cash equivalents, beginning of year 4907 10612 18494 28366 40676 55648 73301 93346 115178 137869

Cash & cash equivalents, end of year 10612 18494 28366 40676 55648 73301 93346 115178 137869 160189

Facebook Inc.

Cash Flow Statement

Fiscal Years Ending Dec. 31 2009 2010 2011 2012 2013 2014 2015

Net income 229 606 1000 53 1500 2940 3688

Depreciation & amortization 78 139 323 649 1011 1243 1945

Lease abandonment expense ‐ ‐ ‐ ‐ 117 ‐31 ‐

Loss (gain) on dosposal or write-off of equipment 1 3 4 15 56 ‐ ‐

Share-based compensation 27 20 217 1572 906 1786 2960

Deferred income taxes ‐ ‐ ‐ ‐186 ‐37 ‐210 ‐795

Tax benefit from share-based award activity 50 115 433 1033 602 1853 1721

Excess tax benefit from share-based award activity ‐51 ‐115 ‐433 ‐1033 ‐609 ‐1869 ‐1721

Other adjustments ‐ ‐ ‐ ‐ ‐ 7 17

Accounts receivable ‐112 ‐209 ‐174 ‐170 ‐378 ‐610 ‐973

Income tax refundable ‐ ‐ ‐ ‐451 400 ‐ ‐

Prepaid expenses & other current assets ‐30 ‐38 ‐31 ‐14 ‐45 ‐123 ‐144

Other assets ‐59 17 ‐32 2 ‐142 ‐216 ‐3

Accounts payable ‐7 12 6 1 26 31 18

Partners payable ‐ 75 96 ‐2 12 ‐28 17

Accrued expenses & other current liabilities 27 20 38 160 ‐38 328 513

Deferred revenue & deposits 1 37 49 ‐60 8 10 ‐9

Other liabilities 1 16 53 43 833 346 1365

Net cash flows from operating activities 155 698 1549 1612 4222 5457 8599

Purchases of property & equipment ‐33 ‐293 ‐606 ‐1235 ‐1362 ‐1831 ‐2523

Purchases of marketable securities ‐ ‐ ‐3025 ‐10307 ‐7433 ‐9104 ‐15938

Sales of marketable securities ‐ ‐ 113 2100 2988 8438 6928

Maturities of marketable securities ‐ ‐ 516 3333 3563 1909 2310

Investments in non-marketable equity securities ‐ ‐ ‐3 ‐2 ‐1 ‐ ‐

Acquisitions of business, net of cash acquired, & purchases of intangible 3 ‐22 ‐24 ‐911 ‐368 ‐ ‐

Acquisitions of business, net of cash acquired, & purchases of intangible‐ ‐ ‐ ‐ ‐ ‐4975 ‐313

Change in restricted cash & deposits ‐32 ‐9 6 ‐2 ‐11 ‐348 102

Other investing activities, net ‐ ‐ ‐ ‐ ‐ ‐2 ‐

Net cash flows from investing activities ‐62 ‐324 ‐3023 ‐7024 ‐2624 ‐5913 ‐9434

Net proceeds from issuance of convertible preferred stock 200 ‐ ‐ ‐ ‐ ‐ ‐

Net proceeds from issuance of common stock ‐ 500 998 6760 1478 ‐ ‐

Taxes paid related to net share settlement ‐ ‐ ‐ ‐2862 ‐889 ‐73 ‐20

Proceeds from exercise of stock options 9 6 28 17 26 18 ‐

Proceeds from long-term debt, net of issuance cost ‐ 250 ‐ 1496 ‐ ‐ ‐

Repayment of long-term debt ‐ ‐ ‐250 ‐ ‐1500 ‐ ‐

Proceeds from sale & lease-back transations 31 ‐ 170 205 ‐ ‐ ‐

Principal payments on capital lease obligations ‐48 ‐90 ‐181 ‐366 ‐391 ‐243 ‐119

Excess tax benefit from share-based award activity 51 115 433 1033 609 1869 1721

Net cash flows from financing activities 243 781 1198 6283 ‐667 1571 1582

Effect of exchange rate changes on cash & cash equivalents ‐ ‐3 3 1 8 ‐123 ‐155

Net increase (decrease) in cash & cash equivalents 336 1152 ‐273 872 939 992 592

Cash & cash equivalents at beginning of period 297 633 1785 1512 2384 3323 4315

Cash & cash equivalents at end of period 633 1785 1512 2384 3323 4315 4907

Cash paid during the period for interest 9 23 28 38 38 14 10

Cash paid during the period for income taxes 42 261 197 53 82 184 273

Facebook Inc.

Common Size Balance Sheet

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Cash & cash equivalents 42.21% 34.61% 27.37% 41.78% 53.86% 62.88% 71.10% 78.95% 87.03% 95.79% 105.68% 117.16% 130.78%

Marketable securities 103.23% 55.22% 75.45% 53.60% 39.89% 30.55% 24.25% 19.80% 16.68% 14.51% 13.05% 12.16% 11.76%

Accounts receivable, gross 14.57% 13.77% 14.65% 14.55% 14.55% 14.55% 14.55% 14.55% 14.55% 14.55% 14.55% 14.55% 14.55%

Less: allowance for doubtful accounts 0.48% 0.31% 0.38% 0.41% 0.41% 0.41% 0.41% 0.41% 0.41% 0.41% 0.41% 0.41% 0.41%

Accounts receivable, net 14.09% 13.46% 14.27% 14.14% 14.14% 14.14% 14.14% 14.14% 14.14% 14.14% 14.14% 14.14% 14.14%

Income tax refundable 0.65%

Prepaid expenses & other current assets 5.86% 6.36% 3.68% 6.29% 6.29% 6.29% 6.29% 6.29% 6.29% 6.29% 6.29% 6.29% 6.29%

Total current assets 166.03% 109.66% 120.77% 115.81% 114.18% 113.85% 115.77% 119.17% 124.13% 130.72% 139.16% 149.75% 162.96%

Property & equipment, gross 52.62% 46.40% 43.61% 38.05% 34.78% 32.72% 31.89% 31.98% 33.08% 35.34% 39.05% 44.70% 53.07%

Less accumulated depreciation 16.01% 14.58% 11.89% 13.47% 14.08% 14.28% 14.56% 15.00% 15.77% 17.02% 18.93% 21.75% 25.89%

Property & equipment, net 36.61% 31.82% 31.72% 24.58% 20.70% 18.43% 17.33% 16.98% 17.31% 18.32% 20.12% 22.94% 27.18%

Intangible assets, net 31.52% 18.11% 9.59% 5.60% 3.57% 2.49% 1.87% 1.51% 1.30% 1.17% 1.11% 1.11%

Goodwill 144.24% 100.55% 70.98% 52.50% 39.96% 31.51% 25.57% 21.40% 18.50% 16.54% 15.32% 14.72%

Goodwill & intangible assets, net 21.88%

Other assets 2.81% 5.11% 4.44% 3.13% 2.32% 1.76% 1.39% 1.13% 0.95% 0.82% 0.73% 0.68% 0.65%

Total assets 227.32% 322.35% 275.59% 224.09% 195.30% 177.57% 168.49% 164.73% 165.29% 169.65% 177.72% 189.80% 206.61%

Accounts payable 1.11% 1.41% 1.09% 1.22% 1.22% 1.22% 1.22% 1.22% 1.22% 1.22% 1.22% 1.22% 1.22%

Partners payable 2.30% 1.62% 1.21% 2.11% 2.11% 2.11% 2.11% 2.11% 2.11% 2.11% 2.11% 2.11% 2.11%

Accrued expenses & other current liabilities 7.05% 6.95% 8.08% 7.67% 7.67% 7.67% 7.67% 7.67% 7.67% 7.67% 7.67% 7.67% 7.67%

Deferred revenue & deposits 0.48% 0.53% 0.31% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48% 0.48%

Current portion of capital lease obligations 3.04% 0.91% 0.04% 0.04% 0.03% 0.03% 0.02% 0.02% 0.02% 0.01% 0.00% 0.00% 0.00%

Total current liabilities 13.97% 11.42% 10.74% 11.53% 11.52% 11.51% 11.51% 11.51% 11.51% 11.50% 11.49% 11.49% 11.49%

Capital lease obligations, less current portion 3.01% 0.95% 0.60% 0.36% 0.22% 0.13% 0.08% 0.04% 0.01% 0.00% 0.00% 0.00% 0.00%

Long-term debt

Income tax payable 11.26% 9.55% 13.71% 11.50% 11.50% 11.50% 11.50% 11.50% 11.50% 11.50% 11.50% 11.50% 11.50%

Deferred tax liabilities 7.92% 0.91% 0.91% 0.91% 0.91% 0.91% 0.91% 0.91% 0.91% 0.91% 0.91% 0.91%

Contingent consideration liability 1.49% 1.49% 1.49% 1.49% 1.49% 1.49% 1.49% 1.49% 1.49% 1.49% 1.49%

Other liabilities,net 2.57% 2.95% 1.50% 1.38% 1.37% 1.37% 1.38% 1.39% 1.40% 1.40% 1.41% 1.41% 1.41%

Total liabilities 30.81% 32.79% 28.94% 27.17% 27.01% 26.92% 26.87% 26.84% 26.82% 26.80% 26.80% 26.80% 26.80%

Convertible preferred stock

Additional paid-in capital 156.21% 242.46% 194.59% 137.43% 101.70% 77.44% 61.09% 49.58% 41.50% 35.87% 32.07% 29.70% 28.53%

Accumulated other comprehensive income (loss) 0.18% ‐1.83% ‐2.54% ‐1.79% ‐1.33% ‐1.01% ‐0.80% ‐0.65% ‐0.54% ‐0.47% ‐0.42% ‐0.39% ‐0.37%

Retained earnings 40.13% 48.93% 54.59% 61.28% 67.92% 74.23% 81.32% 88.95% 97.52% 107.45% 119.27% 133.69% 151.65%

Total stockholders' equity 196.52% 289.56% 246.64% 196.92% 168.29% 150.66% 141.62% 137.89% 138.47% 142.85% 150.92% 163.01% 179.82%

Facebook Inc.

Common Size Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of revenue 23.82% 17.27% 15.99% 16.63% 16.63% 16.63% 16.63% 16.63% 16.63% 16.63% 16.63% 16.63% 16.63%

Research & development expense 17.98% 21.39% 26.86% 24.12% 24.12% 24.12% 24.12% 24.12% 24.12% 24.12% 24.12% 24.12% 24.12%

Marketing & sales expense 12.67% 13.48% 15.20% 14.34% 14.34% 14.34% 14.34% 14.34% 14.34% 14.34% 14.34% 14.34% 14.34%

General & administrative expense 9.92% 7.81% 7.22% 7.51% 7.51% 7.51% 7.51% 7.51% 7.51% 7.51% 7.51% 7.51% 7.51%

Total cost & expenses 64.38% 59.94% 65.28% 64.49% 64.74% 64.82% 64.44% 64.17% 63.98% 63.86% 63.78% 63.75% 63.76%

Income from operations 35.62% 40.06% 34.72% 35.51% 35.26% 35.18% 35.56% 35.83% 36.02% 36.14% 36.22% 36.25% 36.24%

Interest expense 0.71% 0.18% 0.13% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16%

Interest income 0.24% 0.22% 0.29% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%

Foreign currency exchange gains (losses), net ‐0.18% ‐0.70% ‐0.37% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Other income (expense) 0.01% ‐0.01% 0.03% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Other income (expense), net 0.08% ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Other income (expense), net ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐

Income before provision for income taxes 34.98% 39.39% 34.55% 35.60% 35.36% 35.27% 35.65% 35.92% 36.11% 36.24% 36.31% 36.35% 36.34%

Provision for income taxes 15.93% 15.80% 13.98% 12.85% 12.76% 12.73% 12.87% 12.97% 13.04% 13.08% 13.11% 13.12% 13.12%

Net income 19.05% 23.58% 20.57% 22.75% 22.59% 22.54% 22.78% 22.95% 23.07% 23.16% 23.20% 23.23% 23.22%

Facebook Inc.

Value Driver Estimation

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Marginal Tax Rate Calculation

Federal Statuatory rate 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00%

State income taxes, net of federal tax benefit 1.60% 1.40% 2.00% 1.70% 1.70% 1.70% 1.70% 1.70% 1.70% 1.70% 1.70% 1.70% 1.70%

Foreign rate differential  6.80% ‐3.60% ‐0.90% ‐2.25% ‐2.25% ‐2.25% ‐2.25% ‐2.25% ‐2.25% ‐2.25% ‐2.25% ‐2.25% ‐2.25%

Marginal Tax Rate  43.40% 32.80% 36.10% 34.45% 34.45% 34.45% 34.45% 34.45% 34.45% 34.45% 34.45% 34.45% 34.45%

EBITA Calculation

Total Revenue 7872 12466 17928 25397 34337 45115 57209 70489 84229 97446 108988 117676 122491

‐COGS ‐1875 ‐2153 ‐2867 ‐4224 ‐5711 ‐7503 ‐9515 ‐11723 ‐14008 ‐16207 ‐18126 ‐19571 ‐20372

‐SG&A ‐1778 ‐2653 ‐4020 ‐5550 ‐7503 ‐9859 ‐12502 ‐15404 ‐18406 ‐21294 ‐23816 ‐25715 ‐26767

‐Research and Development ‐1415 ‐2666 ‐4816 ‐6127 ‐8284 ‐10884 ‐13801 ‐17005 ‐20320 ‐23509 ‐26293 ‐28389 ‐29550

‐Amortization of Purchased Intangible Assets 0 0 0 ‐701 ‐658 ‐603 ‐520 ‐357 0 0 ‐2020 ‐17 0

+Implied Interest on Operating Leases 34 38 43 71 87 108 133 165 204 252 311 385 475

EBITA 2838 5032 6268 8866 12268 16374 21005 26165 31698 36688 39043 44368 46277

Less Adjusted Income Taxes

Provision for income taxes 1254 1970 2506 3264 4383 5744 7363 9141 10980 12748 14288 15440 16068

+Tax Shield on Interest expense 24 8 8 14 19 24 31 38 45 53 59 63 66

‐Tax Shield on Interest income ‐8 ‐9 ‐19 ‐22 ‐29 ‐39 ‐49 ‐61 ‐72 ‐84 ‐94 ‐101 ‐105

+Tax Shield  on Foreign Exchange Currency Loss 6 29 24 0 0 0 0 0 0 0 0 0 0

‐Tax Shield  on Other Income 0 0 ‐2 0 0 0 0 0 0 0 0 0 0

‐Tax Shield  on Other Income,net ‐3 0 0 0 0 0 0 0 0 0 0 0 0

+Tax Shield on Op Lease interest 15 13 16 24 30 37 46 57 70 87 107 132 164

Total Adjusted Taxes 1288 2010 2533 3280 4402 5767 7390 9175 11023 12803 14360 15535 16192

Plus Changes in Deferred Taxes

Change in Deferred Taxes 0 987 ‐824 68 81 98 110 121 125 120 105 79 44

NOPLAT: EBITA‐Adjusted Taxes+Change in DT

NOPLAT 1550 4009 2911 5654 7948 10705 13724 17111 20800 24005 24788 28912 30128

Calculation of Invested Capital 

Operating Current Assets

Cash 3323 4315 4907 10612 18494 28366 40676 55648 73301 93346 115178 137869 160189

Cash as percentage of revenue 787 1247 1793 2540 3434 4511 5721 7049 8423 9745 10899 11768 12249

Normal Cash 787 1247 1793 2540 3434 4511 5721 7049 8423 9745 10899 11768 12249

Accounts Receivable 1109 1678 2559 3591 4855 6378 8088 9966 11908 13777 15409 16637 17318

Income Tax Refundable 51 0 0 0 0 0 0 0 0 0 0 0 0

Prepaid Expenses and Other Current assets 461 793 659 1597 2159 2836 3597 4432 5296 6127 6852 7398 7701

Current Operating Assets 2408 3718 5011 7727 10447 13726 17406 21447 25627 29648 33160 35803 37268

Accounts Payable 87 176 196 310 420 551 699 861 1029 1191 1332 1438 1497

Partners Payable 181 202 217 537 725 953 1209 1489 1780 2059 2303 2486 2588

Accrued expenses & other current liabilities 555 866 1449 1949 2635 3462 4390 5409 6463 7478 8363 9030 9399

Deferred revenue & deposits 38 66 56 122 164 216 274 337 403 466 522 563 586

Current Operating Liabilities 861 1310 1918 2917 3944 5182 6571 8097 9675 11193 12519 13517 14070

Net Operating Working Capital 1547 2408 3093 4810 6503 8544 10835 13350 15952 18455 20641 22286 23198

Plus, Net Property Plant and Equipment 2882.00 3967.00 5687 6243 7109 8316 9914 11971 14578 17848 21928 27001 33292

Intangible Assets, Net 0 3929 3246 2435 1924 1610 1423 1320 1273 1264 1279 1312 1357

Capitalized PV of Operating Leases 811 911 1209 1494 1846 2282 2820 3485 4307 5323 6579 8131 10049

Other Operating Assets 221 637 796 796 796 796 796 796 796 796 796 796 796

Plus, Other Operating Assets, net depreciation 1032 5477 5251 4725 4567 4687 5039 5601 6376 7383 8654 10239 12202

Other long term liabilities 202 368 269 350 470 617 790 981 1179 1368 1534 1657 1725

LT Income Tax Liability 886 1190 2458 2922 3950 5190 6581 8109 9690 11210 12538 13537 14091

Less: Other Operating Liabilities 1088 1558 2727 3272 4420 5807 7372 9090 10868 12578 14071 15195 15816

Invested Capital 4373 10294 11303 12506 13758 15740 18415 21832 26038 31107 37152 44331 52876

Calculation of Return on Invested Capital

NOPLAT 1550 4009 2911 5654 7948 10705 13724 17111 20800 24005 24788 28912 30128

Beginning Invested Capital 4317 4373 10294 11303 12506 13758 15740 18415 21832 26038 31107 37152 44331

ROIC 35.90% 91.68% 28.28% 50.02% 63.55% 77.81% 87.19% 92.92% 95.27% 92.19% 79.69% 77.82% 67.96%

Economic Profit: Begin IC * ( ROIC ‐WACC) 

Beginning Invested Capital 4317 4373 10294 11303 12506 13758 15740 18415 21832 26038 31107 37152 44331

ROIC 35.90% 91.68% 28.28% 50.02% 63.55% 77.81% 87.19% 92.92% 95.27% 92.19% 79.69% 77.82% 67.96%

WACC 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40%

Economic Profit  1231 3686 2150 4818 7023 9688 12560 15749 19185 22080 22488 26165 26850

FCF: NOPLAT+Change in  Invested Capital

NOPLAT 1550 4009 2911 5654 7948 10705 13724 17111 20800 24005 24788 28912 30128

Add: Beg Invested Capital 4317 4373 10294 11303 12506 13758 15740 18415 21832 26038 31107 37152 44331

Less: Current Invested Capital 4373 10294 11303 12506 13758 15740 18415 21832 26038 31107 37152 44331 52876

FCF 1494 ‐1911 1902 4451 6696 8723 11049 13694 16594 18936 18744 21733 21583

Facebook Inc.

Weighted Average Cost of Capital (WACC) Estimation

Marginal Tax Rate 36.10%

Cost of equity Calculation

Risk Free Rate  2.67%

+

Beta* 0.948

Market Risk Premium 5%

= Cost of Equity 7.41%

WACC Calculation

Shares outstanding* 2845

MV of share $114

=Total MV of Equity [E] $324,984

MV of debt [D] 1209

Cost of Debt 4.73%

MV of equity $324,984

+

MV of debt 1209

= MV of the firm [V] $326,193

Cost of Equity * 7.41%

(E/V) 0.996

+

Cost of Debt * 4.73%

(1‐Marginal tax Rate) 63.90%

(D/V) 0.004

= WACC 7.40%

Facebook Inc.

Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs:

     CV Growth 2.50%

     CV ROIC 92.92%

     WACC 7.40%

     Cost of Equity 7.41%

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

DCF Model

Discount period 1 2 3 4 5 6 7 8 9 10

NOPLAT  5654 7948 10705 13724 17111 20800 24005 24788 28912 30128

Continuing Value  598841

Free Cash Flow 4451 6696 8723 11049 13694 16594 18936 18744 21733

Net FCF 4451 6696 8723 11049 13694 16594 18936 18744 620574

PV of free cash flows 4145 5806 7042 8306 9585 10815 11491 10592 326520

Value of Operations 394302

Non Operating Assets

Excess Cash 3114

Marketable Securities 13527

Value of Non Operating Assets 16641

Non Operating Liabilities

PV of Operating Leases 1209

PV of employee stock options 911

PV of Capital Lease Obligations 114

Notes payable & short-term borrowings 0

Employee compensation & benefits 0

Long-term debt 0

Pension liabilities 0

Value of Non Operating Liabilities 2234

Equity Value 408709

Shares outstanding 2845

Intrinsic Share Price 143.66

Current Share Price  114

EP Model

Periods to discount 1 2 3 4 5 6 7 8 9 10

Economic Profit 4818 7023 9688 12560 15749 19185 22080 22488 26165 26850

Continuing Value 554510

Net  EP  4818 7023 9688 12560 15749 19185 22080 22488 580674

PV of Economic Profit 4486 6089 7821 9442 11023 12504 13399 12707 305527

Initial Invested Capital 11303

Value of Operations 394302

Non Operating Assets

Excess Cash 3114

Marketable Securities 13527

Value of Non Operating Assets 16641

Non Operating Liabilities

PV of Operating Leases 1209

PV of employee stock options 911

PV of Capital Lease Obligations 114

Notes payable & short-term borrowings 0

Employee compensation & benefits 0

Long-term debt 0

Pension liabilities 0

Value of Non Operating Liabilities 2234

Equity Value 408709

Shares outstanding 2845

Intrinsic Share Price 143.66

Current Share Price  114

For Discounting:

Number of Periods

Today 4/19/2016

Next FYE 10/31/2016

Last FYE 10/31/2015

Days in FY 366             

Days to FYE 171             

Elapsed Fraction 0.467

Intrinsic Value Today 148.53

Facebook Inc.Relative Valuation Models

EPS EPS

Ticker Company Price 2016E 2017E P/E 16 P/E 17

MSFT Microsoft Corporation $55.17 $2.76  $3.06  20.0          18.0         

TWTR Twitter Inc $16.00 $0.55  $0.76  29.1          21.0         

AAPL Apple Inc $109.21 $9.09  $9.96  12.0          11.0         

LNKD Linkedin $114.72 $3.21  $4.16  35.7          27.6         

GOOGL Alphabet Inc. $763.42 $34.49  $40.31  22.1          18.9         

YHOO Yahoo Inc. $36.70 $0.54  $0.61  68.0          60.2         Average 31.2         26.1        

FB Facebook Inc. $114.23 $2.03  $2.72  56.3          42.0         

Implied Value:

   Relative P/E (EPS16)  $    63.21 

   Relative P/E (EPS17) 71.11$    

Facebook Inc.

Key Management Ratios

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Liquidity Ratios

Current Ratio (Current Assets/ Current Liabilities) 11.88 9.60 11.25 10.04 9.91 9.89 10.06 10.36

Cash Ratio (Cash/ Current Liabilities) 3.02 3.03 2.55 3.62 4.68 5.46 6.18 6.86

Quick Ratio (Cash + Other Liquid Assets) / current liabilities 4.03 4.21 3.88 4.85 5.90 6.69 7.41 8.09

Activity or Asset‐Management Ratios

Asset Turnover Ratio (Sales/Total Assets) 0.44 0.31 0.36 0.45 0.51 0.56 0.59 0.61

Receivables Turnover Ratio (Sales/Average Accounts Receivable) 7.10 7.43 7.01 7.07 7.07 7.07 7.07 7.07

Financial Leverage Ratios

Debt‐to‐Equity Ratio (Total Debt/Total Equity) 5.24% 2.52% 2.73% 2.99% 3.19% 3.36% 3.48% 3.59%

Equity Ratio (Total Equity/ Total Assets) 86.45% 89.83% 89.50% 87.88% 86.17% 84.84% 84.05% 83.71%

Interest Coverage (Operating Income) / (Interest Expense) 50.07 217.13 270.65 227.03 225.47 224.92 227.35 229.09

Profitability Ratios

Return on Assets (Net Income/Total Assets) 8.38% 7.32% 7.46% 10.15% 11.57% 12.69% 13.52% 13.93%

Return on Equity (Net Income/Shareholders Equity) 9.70% 8.14% 8.34% 11.55% 13.42% 14.96% 16.09% 16.65%

Gross Margin (Revenue‐COGS)/Revenue 76.18% 82.73% 84.01% 81.48% 81.24% 81.15% 81.53% 81.81%

EBIT Margin (EBIT/Sales) 35.62% 40.06% 34.72% 35.51% 35.26% 35.18% 35.56% 35.83%

Profit Margin (Net Income/Sales) 19.05% 23.58% 20.57% 22.75% 22.59% 22.54% 22.78% 22.95%

Payout Policy Ratios

0 0 0 0 0 0 0 0

Payout Ratio (Divident Payout Ratio) 0 0 0 0 0 0 0 0

Total Payout Ratio (Dividends paid + Repurchases)/NI

Present Value of Operating Lease Obligations (2015) Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013) Present Value of Operating Lease Obligations (2012)

Operating Operating Operating Operating

Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending  Leases Fiscal Years Ending  Leases

2016 209 2015 155 2014 142 2013 142

2017 230 2016 161 2015 142 2014 128

2018 216 2017 158 2016 139 2015 117

2019 200 2018 143 2017 131 2016 110

2020 159 2019 125 2018 112 2017 102

Thereafter 438 Thereafter 359 Thereafter 312 Thereafter 252

Total Minimum Payments 1452 Total Minimum Payments 1101 Total Minimum Payments 978 Total Minimum Payments 851

Less: Interest 243 Less: Interest 190 Less: Interest 167 Less: Interest 140

PV of Minimum Payments 1209 PV of Minimum Payments 911 PV of Minimum Payments 811 PV of Minimum Payments 711

Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases

Pre‐Tax Cost of Debt 4.73% Pre‐Tax Cost of Debt 4.73% Pre‐Tax Cost of Debt 4.73% Pre‐Tax Cost of Debt 4.73%

Number Years Implied by Year 6 Payment 2.8 Number Years Implied by Year 6 Payment 2.9 Number Years Implied by Year 6 Payment 2.8 Number Years Implied by Year 6 Payment 2.5

Lease PV Lease Lease PV Lease Lease PV Lease Lease PV Lease

Year Commitment Payment Year Commitment Payment Year Commitment Payment Year Commitment Payment

1 209 199.6 1 155 148.0 1 142 135.6 1 142 135.6

2 230 209.7 2 161 146.8 2 142 129.5 2 128 116.7

3 216 188.0 3 158 137.5 3 139 121.0 3 117 101.9

4 200 166.2 4 143 118.9 4 131 108.9 4 110 91.4

5 159 126.2 5 125 99.2 5 112 88.9 5 102 81.0

6 & beyond 159 318.9 6 & beyond 125 260.7 6 & beyond 112 227.0 6 & beyond 102 184.7

PV of Minimum Payments 1208.7 PV of Minimum Payments 911.1 PV of Minimum Payments 810.9 PV of Minimum Payments 711.2

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number 

Number of Options Outstanding (shares):  8

Average Time to Maturity (years): 3.66

Expected Annual Number of Options Exercised: 2

Current Average Strike Price: 7.10$           

Cost of Equity: 7.41%

Current Stock Price: $114.23

2016E 2017E 2018E 2019E

Increase in Shares Outstanding: 2 2 2 2

Average Strike Price: 7.10$            7.10$            7.10$            7.10$           

Increase in Common Stock Account: 16                  16                  16                  16                 

Change in Treasury Stock 0 0 0 0

Expected Price of Repurchased Shares: 114.23$        122.70$        131.79$        141.56$       

Number of Shares Repurchased: ‐                ‐                ‐                ‐               

Shares Outstanding (beginning of the year) 2,845 2,847 2,850 2,852

Plus: Shares Issued Through ESOP 2 2 2 2

Less: Shares Repurchased in Treasury ‐                ‐                ‐                ‐               

Shares Outstanding (end of the year) 2,847 2,850 2,852 2,854

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol FB

Current Stock Price $114.23

Risk Free Rate 2.67%

Current Dividend Yield 0.00%

Annualized St. Dev. of Stock Returns 17.54%

Average Average B‐S Value

Range of Number Exercise Remaining Option of Options

Outstanding Options of Shares Price Life (yrs) Price Granted

Range 1 0 0.11 0.60 114.12$      51$                     

Range 2 1.182 0.32 1.50 113.92$      135$                  

Range 3 0.968 1.85 3.00 112.52$      109$                  

Range 4 1.147 2.95 3.60 111.55$      128$                  

Range 5 3.500 10.39 4.60 105.04$      368$                  

Range 6 1.200 15.00 4.80 101.04$      121$                  

Total 8 7.10$           3.66 107.79$      911$                  

Beta

Beta

143.66 0.6 0.7 0.8 0.948 1 1.1 1.2 143.66 0.6 0.7 0.8 0.948 1 1.1 1.2

4% 294.27 251.46 218.91 182.93 172.75 155.83 141.69 1.75% 197.42 172.38 152.53 129.74 123.13 111.97 102.49

4.25% 276.73 236.19 205.40 171.41 161.81 145.85 132.53 2.00% 207.99 180.25 158.55 133.95 126.88 115.00 104.97

5% 261.03 222.54 193.34 161.15 152.06 136.97 124.38 2.25% 220.11 189.12 165.25 138.57 130.97 118.28 107.64

Risk Premium 4.75% 246.91 210.28 182.52 151.95 143.33 129.02 117.09 CV Growth 2.50% 234.15 199.20 172.75 143.66 135.46 121.86 110.53

5% 234.15 199.20 172.75 143.66 135.46 121.86 110.53 2.75% 250.59 210.76 181.22 149.30 140.41 125.76 113.67

5.25% 222.54 189.15 163.89 136.15 128.34 115.38 104.60 3.00% 270.12 224.16 190.84 155.57 145.88 130.05 117.08

6% 211.95 179.98 155.83 129.32 121.86 109.50 99.22 3.10% 279.01 230.13 195.07 158.29 148.24 131.88 118.53

5.75% 202.26 171.60 148.45 123.08 115.95 104.13 94.32 3.50% 322.74 258.49 214.65 170.55 158.82 140.00 124.89

6% 193.34 163.89 141.69 117.36 110.53 99.22 89.83 3.75% 359.37 281.00 229.63 179.58 166.53 145.82 129.40

6.25% 185.12 156.80 135.46 112.11 105.55 94.71 85.71

CV Growth

143.66 1.75% 2% 2.25% 2.50% 2.75% 3.10% 3.25% 3.50% 3.75%

6.00% 179.78 188.41 198.18 209.35 222.23 244.01 255.04 276.36 302.42

6.50% 158.38 164.92 172.22 180.44 189.75 205.09 212.68 227.00 243.94

7.00% 141.15 146.23 151.83 158.06 165.02 176.27 181.73 191.88 203.58

WACC 7.40% 129.63 133.83 138.44 143.52 149.14 158.11 162.42 170.34 179.35

8.28% 109.41 112.28 115.40 118.78 122.46 128.22 130.94 135.84 141.28

8.50% 105.21 107.84 110.68 113.76 117.11 122.31 124.75 129.15 134.01

9.00% 96.66 98.83 101.16 103.67 106.38 110.56 112.50 115.98 119.80

9.50% 89.26 91.07 93.00 95.07 97.29 100.70 102.27 105.07 108.11

10.00% 82.81 84.33 85.94 87.67 89.51 92.32 93.61 95.89 98.36

CV Growth

143.66 1.75% 2% 2.25% 2.50% 2.75% 3.00% 3.25% 3.50% 3.75%

32% 74.18 76.35 78.73 81.35 84.26 87.49 91.12 95.21 99.86

34% 85.22 87.79 90.60 93.70 97.14 100.96 105.25 110.09 115.59

36% 97.99 101.02 104.35 108.01 112.07 116.59 121.65 127.36 133.86

Advertising CAGR 38% 112.74 116.31 120.24 124.56 129.34 134.67 140.65 147.39 155.05

40% 129.74 133.95 138.57 143.66 149.30 155.57 162.61 170.55 179.58

42% 149.31 154.26 159.69 165.67 172.30 179.68 187.95 197.29 207.90

44% 171.79 177.60 183.97 190.99 198.77 207.43 217.14 228.09 240.55

46% 197.57 204.38 211.84 220.06 229.17 239.32 250.69 263.52 278.11

48% 227.09 235.04 243.77 253.38 264.03 275.89 289.19 304.18 321.24

Beta

143.66 0.6 0.7 0.8 0.948 1 1.1 1.2

32% 128.98 110.60 96.68 81.35 77.03 69.85 63.86

34% 149.70 128.09 111.72 93.70 88.62 80.18 73.15

36% 173.79 148.40 129.17 108.01 102.04 92.14 83.88

Advertising CAGR 38% 201.76 171.95 149.38 124.56 117.56 105.94 96.27

40% 234.15 199.20 172.75 143.66 135.46 121.86 110.53

42% 271.58 230.67 199.71 165.67 156.08 140.18 126.93

44% 314.75 266.94 230.76 190.99 179.79 161.22 145.76

46% 364.45 308.65 266.44 220.06 207.00 185.35 167.34

48% 421.54 356.54 307.38 253.38 238.18 212.99 192.03

Beta

143.66 0.6 0.7 0.8 0.948 1 1.1 1.2

8% 289.00733 245.94585 213.33762 177.45781 167.34 150.55536 136.56687

10% 276.2955 235.11512 203.93346 169.62642 159.9529 143.9063 130.53405

12% 263.58342 224.28419 194.52912 161.79488 152.56566 137.25712 124.50113

14% 250.87103 213.453 185.12458 153.96318 145.17828 130.60781 118.46809

Cost of Revenue 16.63% 234.15372 199.20956 172.75723 143.66419 135.46359 121.86373 110.53443

18% 225.44519 191.78975 166.31473 138.29917 130.40294 117.3087 106.40158

20% 212.7316 180.95757 156.90934 130.46679 123.01493 110.65884 100.36806

22% 200.01746 170.12493 147.50356 122.63411 115.62663 104.00874 94.334315

24% 187.30265 159.29174 138.09733 114.80106 108.23799 97.358328 88.300309

143.66 0.6 0.7 0.8 0.948 1 1.1 1.2

18% 273.07447 232.37074 201.55055 167.64203 158.08109 142.22151 129.0054

20% 260.36231 221.53974 192.14616 159.81045 150.69382 135.5723 122.97245

22% 247.64984 210.70849 182.74156 151.9787 143.30639 128.92295 116.93938

R&D Expenses 24.12% 234.17424 199.22705 172.77241 143.67683 135.47551 121.87446 110.54417

26% 222.22379 189.04506 163.93157 136.31458 128.53095 115.62374 104.87279

28% 209.51007 178.21277 154.52609 128.48213 121.14286 108.97383 98.839214

30% 196.79577 167.38001 145.1202 120.64936 113.75448 102.32365 92.80541