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| Take Home Exam in Corporate Finance | Case Study: Facebook (FB) | | |

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Question 1 (Focus: FB’s 2012 annual report) (1) What is the business model of FB, i.e., how do they generate revenues?

Facebook is the biggest social-media platform worldwide with $1.06 billion MAU (monthly active users) and $618 million DAU (daily active users).
Its business model is set up on three pillars: Facebook users, developers and marketers.
a) Users
Facebook creates a direct value proposition for Users.
The company creates value for users by enabling users to * Connect and Share with friends * Discover and Learn about News around the world shared by the user’s personal contacts * Express themselves and share what they think about and what matters to them * Stay connected everywhere, especially due to Facebook mobile applications.
With its users Facebook does not generate direct revenues, since the usage of all Facebook products are free of charge.
However the users indirectly generate revenues. It is only possible for Facebook to create revenues with marketers and developers because of its amount of users.
b) Developers
Developers get attracted by the huge customer base of Facebook. They have the opportunity to build up applications and websites which connect with Facebook.
Facebook offers a variety of tools and application programming interfaces on its Facebook Developers Platform that easily interacts with Facebook. Due to that easy access there are more than 10 Mio applications developed by 2012.
Facebook enables developers to * achieve growth by using the global user base and distribution channels. * develop more personalized products with a high customer Engagement * use Facebook’s easy-to-use online payment infrastructure and get a fair Monetization for their applications.
Facebook provides developers with free-of-charge software tools on the Facebook Developer's Platform. This leads to the enormous amount of different applications. Every Developers idea can be followed without any initial cost, but with a small chance of big later revenues.
However, Facebook charges a percentage on all revenues Developers make with the Facebook applications and websites.
c) Marketers
Thirdly Facebook is very interesting for Marketers. On the one hand Marketers profit from Facebook’s huge user base, on the other hand they may profit from Facebook’s knowledge about their users.
Facebook claims that the value added per advertisement is high due to Facebook unique combination of reach, relevance, social context. The company sees unique characterics in * reach: more than 1 bilion users * relevance: known demographic factors and interests allow specialized commercials * social context: indirect recommendations by linking friends and companies/products that friends are connected with * engagement: possibility to create interaction between a company/product and the customer in the social internet * ongoing relationship with customer through customer Facebook page possible
Facebook is able to generate revenues with marketers mostly because they are able to sell internet advertisements on their webpage. Most important is the reach and the ability to sell specialized advertisements.

(2) How does the management of FB want to generate growth?
Facebook achieved huge user growth rates in 2012. To achieve growth rates in revenues in future Facebook has a strategy with the following key elements: * Expand the global user community:
There is still a large amount of Internet and mobile device users, which are not connected on Facebook. Facebook wants to focus their efforts on big but less-penetrated markets such as Brazil, India, Mexico and Japan. * Built great social products:
Facebook prioritizes product development investments by the engagement between users, marketers and developers. The company hopes that this will also lead to the most compelling user experience. * Make the mobile products engaging and easily available:
Facebook works together with mobile companies to increase the performance of its mobile applications. The company finds the mobile performance critical for the long-term user growth rate and therefore prioritizes investments in that area. * Enable Developers to Build Great Social Products Using the Facebook Platform:
Facebook wants to increase its cooperation with Developers. The company believes in great synergies between the work of the developers, marketing revenues and user knowledge. * Improve Ad Products for Marketers and Users
Facebook is investing in approving the existing Marketing methods. Furthermore the company wants to create new marketing options, well aware of the conflict between user satisfaction and more advertisement options.

(3) What are major risks for the company according to the management? * If Facebook fails to retain existing users or add new users, or if their users decrease their level of engagement with Facebook, their revenue, financial results, and business may be significantly harmed * Facebook may not be successful in their efforts to further monetize the Facebook Platform * Actions by governments to restrict access to Facebook in their countries could substantially harm their business and financial results * If Facebook is not able to maintain and enhance their brand, or if events occur that damage their reputation and brand, their ability to expand their base of users, developers, and marketers may be impaired, and their business and financial results may be harmed * Facebook generates a substantial majority of their revenue from advertising. The loss of marketers, or reduction in spending by marketers with Facebook could seriously harm their business * Growth in the use of Facebook through mobile products as a substitute for use on personal computers may negatively affect their revenue and financial results * The business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to their business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm their business * Facebook´s business is dependent on their ability to maintain and scale their technical infrastructure, and any significant disruption in their service could damage their reputation, result in a potential loss of users and engagement, and adversely affect their financial results * Computer malware, viruses, hacking and phishing attacks, and spamming could harm their business and results of operations * Facebook plans to continue expanding their operations abroad where they have limited operating experience and may be subject to increased business and economic risks that could affect their financial results * Facebook has a substantial amount of indebtedness which could adversely affect their financial condition and their ability to obtain additional capital on reasonable terms when required * Changes in tax laws or tax rulings could materially affect their financial position and results of operations (4) How profitable is Facebook? What is the major reason for the latest development in profitability?
The company did $5.1 billion in revenues in 2012, it increased $1.38 billion, or a raise of 37% compared to 2011. The increase was due primarily to a 36% increase in advertising revenue during 2012 as compared to 2011.
The overall Net income was $ 0.053 billion, or 3 cents a share in 2012, it decreased $0.947 billion compared to 2011. Payments alone were $810 million in last year’s business. The net profit margin reduced from 27% in 2011 to 1.04% in 2012 (its operating profit margin also diminished from 47% in 2011 to 10.57% in 2012). The low net profit margin is an indicator for an unhealthy company.
Facebook´s business throws off a ton of cash. Net operating cash in 2012 was $1.6 billion, up 4% from 2011. Free cash flow (a related measure) was $37 million in 2012. The company ended the year with $9.6 billion in cash.
The latest development in the fourth quarter of 2012 arises from aggressively ramping up advertisements aimed at its users, including on mobile phones. Facebook increased its revenue by 40% from the same period a year ago. As part of its aggressive appeals to mobile users, Facebook offered a way for users to make free voice calls using the Internet and leave voice massages for friends unable to text.
Also Facebook showed more advertisements to desktop users and its mobile subscribers.

(5) What does the capital structure of FB look like?

The capital structure discloses the way a company finances its assets through combinations of equity and debt.
Facebook’s Total Assets account $ 15.103 billion and its Total Stockholder’s Equity account $ 11.755 billion on December 31, 2012.
The Total Debt Ratio, which gives the measure of the percentage of debt that Facebook has, equals 0.2217 [= (Total Assets – Total Equity) / Total Assets].
Consequently due to only 22.17 % of debt, the risk associated with Facebook’s bankruptcy in temporary struggles is not too high.
The Debt to Equity Ratio, which is indicating the relative proportion of Facebook’s debt to its equity, equals 0.2848 [= (Total Assets – Total Equity) / Total Equity].
The Equity Multiplier, which is indicating the relative proportion of Facebook’s assets to its equity and is a measure of financial leverage, equals 1.2848 [= Total Assets / Total Equity].

Question 2 (Focus: Morgan Stanley Research report) (1) What is the rating for FB’s Stock? How do the analysts come up with the valuation?
The analysts rating for the Facebook stock is „overweight“, which means that you should buy the stock and give it a bigger weight in your stock-portfolio. The price target of the stock is $34.00which is nearly $7.00 higher than the stock price from Feb. 25, 2013.
The analysts come up with this rating because of the following reasons: * Facebook is the leading global social network and possesses a large and growing network of users and an even larger database of self-disclosed interests which allows Facebook to deliver social enabled ads with high targeting & recall rates. * Facebook has a developer platform which allows app-makers and web-publishers to leverage the Social Graph to provide an instant personalization to users and better ad targeting for brands * Facebook is already achieving strong profitability, and will likely not be a cash tax payer until 2015/2016

(2) What are major risks for the company according to the analysts?
The major risks for Facebook according to the analysts are: * The consolidated ad pricing is below the industry peers, there is room for substantial upside due to Newsfeed ads but the company might not be able to achieve pricing leverage across trillions of annual ad impressions. * The mobile ad market remains in the infancy. Facebook will probably lead the market in mobile ad targeting but agency and brand transitions to mobile may take longer than expected * Facebook must find the right balance of information sharing that will enable it to deliver favorable ad targeting, but not antagonize users or legislators who desire greater levels of privacy

(3) How can FB generate growth according to the analysts? * With the use of higher-value social ad formats Facebook could boost monetization meaningfully over time * The analysts also consider that mobile usage may provide additional revenue opportunities * Facebook has also the potential to create and launch new products like a social shopping destination or an ad network
Question 3 (Focus: Credit Suisse research report):

(1) What is the rating for FB’s Stock? How do the analysts come up with the valuation?
The analysts rating for the Facebook stock is „neutral“ which means, there is no need to invest in this stock or to sell parts of the stocks. They forecast no huge decrease or increase potential and assume a sideward reaction of the NASDAQ listed share.
CS maintains their positive bias on Facebook, but they think that the shares already reflecting what they assume for the future, like the near-to-mediumterm benefits of both mobile monetizations as well as FBX. Because of that they maintain the neutral rating but raised the target price from $24.00 to $31.00. On January 28th, 2013 the actual price was $32.46.

(2) What are major risks for the company according to the analysts?
According to CS a major risk is the mobile business, that pricing lags especially in North America and Europe behind that of desktop. The long-term expectation is that mobile will close the gap for these two regions while surpassing APAC and ROW and the user base will likely skip the PC and move directly to smart phones and tablet. Consequently the mobile business is the key risk for the Facebook Company.

(3) How can FB generate growth according to the analysts? * Facebook sets to capitalize on the continuous movement of brand advertising budgets online, so the analysts from CS believe that near-to-medium term FB can generate growth using the mobile monetization as well as FBX. * Also the analysts have assumed that the pickup in mobile monetization, which just on run-rate should exhibit a material increase sequentially, does not come at the expense of desktop revenue due to the benefits Facebook is seeing with the release of FBX. * FBX has given advertisers a reason to take spending on the Facebook platform beyond just experimental allocation and further into commercial deployment. * Growth in mobile engagement which currently has limited monetization, future monetization initiatives do not materialize, limited ability for public shareholders to influence key decisions because of dual class voting stock, deteriorating global economy, competition, unpredictable investment spending, and potential impacts from data privacy and data protection regulations/laws.

Question 4 (Focus: Credit Suisse + Morgan Stanley research report):
In comparison to the Morgan Stanley report we prefer the Credit Suisse report, because it is much more clearly, it contains charts and a better overview of Facebook’s user structure. The investment summary of the Credit Suisse report is more structured and includes all important key facts. We also think that the calculations are easier to comprehend and because of that they are more convincing. We agree with the Credit Suisse’s rating that the stock rating should be neutral rather than overweight, because Facebook’s business model has to face different uncertainties in the future.

Question 5 (Focus: research reports + annual report):

i. The growth rate of the detailed planning phase:
Fundamental growth rate: g=ROE ×(1-payout ratio)
ROE=Net IncomeTotal Equity ROE= $1000M$4899M=0.2041
Payout Ratio= DividendsNet Income Payout Ratio= $49,171,689.84$1000M =0.04917

g=0.2041×1-0.04917=0.1941

ii. The growth rate of the terminal-value phase:
Compound quarterly growth rate=SalesTSalest01(T-t0)-1 quarterly growth rate=15864,114273,91(20-1)-1=0.005575= 0.5575% annual growth rate=4 ×0.5575%=2.23%

iii. Market risk premium and risk free rate:
Risk free rate=( i=123rf) 123=0,0329 Market risk premium= ( i=123rm) 123=0,0526

iv. Equity Beta:
The result of the regression analysis is β = 0.0176. v. WACC:
CAPM= kL=rf+ β (rM-rf)
CAPM= kL=0.0329+ 0.0176 0,0526-0,0329=0.0332
WACC= kL+ EQEQ+Debt+i×1-s×DebtEQ+Debt
WACC= 0.3387+ 11,75511,755+3,348+0.0146×1-0.35×3,34811,755+3,348=0,8136

vi. Free Cash Flows:
1 Projected FCF 2013=$1,387M
2 Growth Rate=0.1941
3 Annual discounted (45;35;25;15)

Year | 2013 | 2014 | 2015 | 2016 | 2017 | FCF | 1,387 | 1,602.3734 | 1,788.9858 | 1,981.7741 | 2,187.6447 |

vii. Company Valuation:
1Cost of capital=0,8136%
2 FCF= 1,387(13);1,602.3734(14); 1,788.9858(15); 1,981.7741(16);2,187.6447(17)
3 Growth in the terminal value phase=2.23%

Valuation based on the WACC model
= i=1TFCF(1+WACC)t+ FCF×(1+g) (1+WACC)T×(WACC-g)-Debt0
=$5.102.994.359 (market capitalization)

viii. Comparison to market values:
Compared to the actual market price on 01/01/2013 which was $63.14 billion, our calculated market price is nearly six times higher which seems to be way too high. Potential deviations arise from insecure growth rates, unpredictable free cash flows and other values like debts which are uncertain in the future.

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...Using Facebook to Teach Rhetorical Analysis Jane Mathison Fife The attraction of Facebook is a puzzle to many people over the age of thirtyfive, and that includes most college faculty. Yet students confess to spending significant amounts of time on Facebook, sometimes hours a day. If you teach in a computer classroom, you have probably observed students using Facebook when you walk in the room. Literacy practices that fall outside the realm of traditional academic writing, like Facebook, can easily be seen as a threat to print literacy by teachers, especially when they sneak into the classroom uninvited as students check their Facebook profiles instead of participating in class discussions and activities. This common reaction reflects James King and David O’Brien’s (2002: 42) characterization of the dichotomy teachers often perceive between school and nonschool literacy activities (although they are not referring to Facebook specifically): “From teachers’ perspectives, all of these presumably pleasurable experiences with multimedia detract from students’ engagement with their real work. Within the classroom economy technology work is time off task; it is classified as a sort of leisure recreational activity.” This dichotomy can be broken down, though; students’ enthusiasm for and immersion in these nonacademic literacies can be used to complement their learning of critical inquiry and traditional academic concepts like rhetorical analysis. Although they read these texts daily...

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