Facebook Valuation Proven at Zero Dollars
July 8, 2008 · Print This Article
I’m getting extremely tired of hearing the media and lots of really smart people refer to Facebook as being worth fifteen billion dollars. Not because I don’t think Facebook is worth $15 billion. It very well might be, even though with their about $100 million in 2007 revenue that’s a 150x multiple on revenue, only about 10 times out of scale from the other most successful companies in the hottest software sectors right now. What’s killing me is the fact that everyone is arriving at this incredible valuation based on flawed logic.
As the New York Times reported in October of 2007, Microsoft made a $240 million investment in Facebook and in exchange received a 1.6% ownership position in the company. If you scale this up (240/X=1.6/100) by solving for $X = (($240 million * 100%) / 1.6%) you do reach a big nice round number of $15 billion. Maybe the math worked out too perfectly for anyone to look any deeper into the situation or maybe people wanted Facebook to be worth $15 billion. Whatever the reason, the logic isn’t there.
From day one Microsoft approached the deal as an investment in extending the reach of their advertising platform. But this deal has been publicized as a cash-for-equity purchase, so how does that extend Microsoft’s ad network real estate? The answer is in the much neglected fact that the deal wasn’t about cash in exchange for stock, it was for stock and a multi-year exclusive right to non-US advertising real estate on the Facebook platform. The original New York Times article mentions that “As part of the deal, Microsoft will sell the graphical banner ads appearing on Facebook outside of the United States, splitting the revenue. ” So, in addition to 1.6% of the company’s stock Microsoft also purchased many billion advertising impressions over a number of years that they can sell to publishers in their ad network and they can keep 1/2 (or maybe another percentage, this isn’t clear by the wording I’ve seen) of the revenue for themselves.
For this exact reason it was widely publicized that Google and Microsoft were dueling for the right to make the investment in Facebook, in much the same manner that the two fight over online advertising market share already. As many who watched the deal go down said, Microsoft simply could not afford to lose the relationship with Facebook considering their distant second place to Google already in publisher adoption among their ad platform. In consideration of Microsoft’s desperation they may have had little interest at all in the equity position they received, further tipping the allocation of the $240 million toward the value they will receive from the advertising inventory reach and revenue share.
Furthermore, as the New York Times mentioned, “Microsoft has an existing deal with Facebook to run banner ads on the site in the United States through 2011″ which implies that an existing relationship with Facebook might have been challenged in some way had Microsoft not stepped up to the plate to nab the non-US advertising inventory, especially so if Google had secured it instead of them. After the deal closed Microsoft was very positive about the potential inventory reach and revenue share value of the new international ad inventory on Facebook. As the New York Times reported “In a conference call with journalists and analysts, Kevin Johnson, president of the platforms and services division at Microsoft, described the deal as a “major advertising syndication win for Microsoft.”"
The real question behind all of this is, what is that worth to Microsoft? In fact, if it’s worth more than $240 million then technically Facebook should be valued at $0 using the same logic and math applied to calculate the $15 billion valuation (ie: $240 million = A + B, if A = 1.6% of Facebook’s stock and B = Microsoft’s share of non-US advertising revenue, then by simple logic if B = $240 million then A is equal to 0, then if 1.6% of the company is worth zero notwithstanding rounding error then 100% of Facebook is worth $0 via the scaling equation I outlined earlier). It’s even more fun to consider that revenue value to Microsoft being greater than $240 million. As you scale the value upwards Facebook’s value becomes increasingly negative. So, assuming the deal will be cash flow positive to Microsoft (or discounted cash flow positive) then if you believe Facebook is at least worth $1 then you negate the fact that it could be worth $15 billion.
I guess it was appropriate today that “news” site The Register, with tongue appropriately pressed to cheek, reported an astronomical drop in Facebook’s value per Facebook’s recent approximations of their own value in court papers related to the ConnectU lawsuit. By their logic, nicely stacked on top of the flawed logic I’ve discussed above, Facebook lost $11.25 billion in value just during the day today. Talk about a recession! That seems like appropriate punishment for all the shenanigans the media has had in doing the math on Facebook’s valuation to date. At least now with Facebook’s approximation of their own value the media will finally have another good data point that they can completely ignore for the sake of a good whiplash headline.
I think the MS investment was 100% about getting Facebook off the market and had nothing to do with a “real” valuation.
Cast your mind back… Before MS did the deal, rumors were swirling that Facebook was about to get bought for $3-5B. It would have looked very bad for MS to lose yet another hot acquisition to Google (or anyone else). They were/are still battling the perception that they don’t understand the internet yet.
For a mere $240M, which is chump change for MS, they took Facebook off the market. I think it was a very clever strategic play.
For Facebook, it was more than enough cash to keep everything running nicely. I believe MS knew everyone would do the math and come up with the $15B valuation, and that was more than any suitor was likely to pay. Not even Google was going to spend $15B to buy Facebook.
The advertising math was simply an effective smoke screen.
The beautiful part is that the media swallowed this BS so thoroughly that it became real, at least in the mind of the Facebookers. I think some of the shine is off that deal now — there have been several reports of Facebookers trying to sell stock based on a $2-3B valuation through private broker services…
But at the end of the day, MS made sure no-one else could acquire Facebook, and they did it for pennies on the dollar.
Very smart.
Good points and analysis on the MS “investment” in Facebook. I think it speaks to the puts and calls of a large partnering/strategic investment deal. For the company partnering with and/or allowing investment from a behemouth, beware (the appearance of) outsized valuations and any lock-up of strategic platforms or channels.
I am, however, left wondering how MS could be so savy in structuring the Facebook deal (based on Aaron’s and NickN’s analysis), yet do such a poor job of their play for Yahoo. Maybe it was different cooks in the kitchen…
@NickN,
How exactly did the MS investment take Facebook off of the market? Did they get a controlling interest in the Board of Directors?
As Aaron said, the deal was for 1.6% + international ad rights, which doesn’t seem like enough to give them any say at all over who can or can’t buy Facebook, unless there’s something I’ve missed.
I don’t think anyone else in big business is the least bit fooled by the $15B valuation, and there’s no reason (that I know of) that they have to stick to that number just because MS did.
If I’m being an id10t, tell me what I’ve missed. Do they have exclusive rights to the US advertising as well?
@Aaron,
Clearly, this has been bugging you for months
I’m glad you got it off your chest.
I love your “pie-in-the-sky” photo.
I would like to point out a typo in your title, though. I believe it should read “Facebook Valuation Proven at ZeroMillion Dollars”.
Ryan? What do you think?
Completely agree Aaron. Can’t tell you how many people I’ve had to tell that FB really wasn’t worth $15B.
Here’s a another good article on TheRegister about it:
http://www.theregister.co.uk/2007/10/25/microsoft_facebook_comment/
Wes, that Register article is priceless. My favorite excerpts are as follows:
In reference to Google and Microsoft fighting over Facebook like “Two combs fighting over a bald man…”
Also about Web 2.0 “Perhaps they’ll realise that web 2.0 is not there to “connect you with the people around you” and not about some pseudo-academic “social graph”. That’s the bait. The switch is the big data centre pumping adverts based on your age, where you live, who you’re friends with, what you like doing for fun, your politics and your grandmother’s shoe size.”
I’ll rewrite the Facebook homepage messaging to match:
“Facebook is a social utility that connects you with the people around you.” err “Facebook is a social privacy extraction tool that connects you with advertisers who value your personal information.”
Admittedly, for me, it’s a trade off I’m willing to make. Hey, it’s really useful sometimes!
@ Wes: You’ve got to remember the setting. MySpace had sold for $500M or so and everyone thought that was crazy. A few months later that started to look cheap. Values were skyrocketing.
My point wasn’t that the _real_ valuation was $15B, it was that the Facebook guys & the media bought in to the hype fire that MS was helping to fuel. If one company values you at $15B and you more or less believe them, $3.5B starts to look like an insult. And don’t forget that Facebook used that MS valuation to raise other money without giving up much equity (which probably also helped make the valuation “real”).
So I stand by my eariler point. For $240M, MS were able to put Facebook beyond the reach of other potential suitors.
@ John: In my previous offline experience, I’ve seen MS be _very_ savvy in the deals they’ve cut, but I totally agree that the Yahoo debacle has been absurd. My guess is that “under new management” has a lot to do with it…
@Nick,
I see your point now, but do you think Facebook really believed that they were worth that? It sounds like they knew exactly what MS was buying, and why they were paying so much for so little equity. I think the media bought into the $15B number, and Facebook certainly used that to their advantage with other investors, but I don’t think the Facebook guys themselves ever believed those numbers.
I think MS got the best of Yahoo. The basically tricked them into devaluing themselves, at the expense of their shareholders. Now they have to explain why they didn’t accept the (very generous) MS offer, which opens the doors for MS to step in later at a much better (for MS) price.
@ Aaron,
Yeah, I think that web 2.0 “bait-and-switch” quote was my favorite as well, as far as being right on-target.
Well the amazing thing to me is that microsoft only gets 1.6% , what !!!
Alot of companies in my opionion are over valued there are alot of variables when it comes to valueing a company sometimes I feel like the analyst are paid to say bullshit because BIG NUMBERS sound cool.
Peace
ps.
sorry for typos
[...] dem Vergleich in der vergangenen Woche toben die Spekulationen um den realen Wert des Unternehmen Facebook. Ein Kriterium ist sicher Wachstum. Mark Zuckerberg, [...]
Bankers are notorious for being conservative when thinking about investments or loaning capital. Why not follow their practices? Before investing any amount in a company I would certainly look at the bottom line. How much do they make versus what they spend? Google is worth what it is because it makes bank. It is a dangerous game trying to quantify potential.
So the question is, what is Facebook actually worth? It’s so hard to speculate with companies growing as quickly as Facebook who also have yet to really iron out their revenue model.
However, since their blog post indicates that they get 30 billion page views per month (http://blog.facebook.com/blog.php?post=2245132130), that’s about 30 million CPM per month. Even at a rate of $2 CPM for advertising, they are probably looking at potential with their current traffic of like $60 million/month or $720 million/year if/when they are able to monetize their page views with even some run of network advertising.
What is a growing technology company that is making (they’re not really making it, but let’s pretend since they have the traffic to) $720 million/year worth? My guess is somewhere in the $5 billion to $6 billion range. Whether that estimate is high or low really depends on what average CPM rates they can command.
[...] dem Vergleich in der vergangenen Woche toben die Spekulationen um den realen Wert des Unternehmens Facebook. Ein Kriterium ist sicher Wachstum. Mark Zuckerberg, [...]