Before you start scrambling to get a piece of the Facebook pie, it's worth looking at a few glaring risk factors.
Would you give this guy $2 million?
Excuse me for raining on the Facebook parade, but yesterday's news about the $450 million investment by Goldman Sachs (GS) and $50 million from Russia's Digital Sky Technology didn't move me the way it seemed to move others. This despite the suggested $50 billion valuation, as big and beautiful a number as the stock market has seen in some time. I am certainly not moved in the same way it appears to have moved Goldman's own clients: the Wall Street firm has pledged to line up another $1.5 billion in sales to its high net worth investors, who are said to be champing at the bit to get a piece of the action, which starts with a $2 million minimum. Not that I have $2 million lying around, but I wouldn't buy this stock if I did.
Reason #1: Someone who knows a lot more than I do is selling. While the identities of the specific sellers remain unknown, the current consensus seems to be that most will be from venture capital investors like Accel Partners, Peter Thiel, and Greylock Partners. Maybe Mark Zuckerberg will kick in $50 million or so himself, just for some fooling around money.
But it's not a dilutive primary offering from the company. "Facebook needs no cash!" say its cheerleaders. Okay, fine. Let's just say for argument's sake that it is early stage investors who are selling. Why would they sell? Because they're in need of cash to invest somewhere else? The way the social network is talked about these days, it's the best investment opportunity in town. So why would anyone want to forsake it? And don't give me that crap about VCs being "early stage" and wanting to cash out of a "mature" investment. These people are as money hungry as any other institutional investor, and would let it ride unless….they saw something that suggested that the era of stupendous growth was over.
Facebook reached 500 million users in July. There's been no update since, even though the company had meticulously documented every new 50 million users to that point. Might the curve have crested? And let's not even talk about the fact that they don't really make much money per user — a few dollars a year at most. (Its estimated $2 billion in 2010 revenues would amount to $4 per user at that base.) I certainly haven't spent any money on the site, despite being a fairly regular visitor. And any advertiser who is trying to target me on the social network is wasting their money. But that's just me.
Reason #2: Goldman Sachs. I've got nothing against Goldman Sachs. Hell, I worked there. But when Reuters' Felix Salmon says that the Goldman investment "ratifies" a $50 billion valuation, he's only half right. That is, someone, somewhere—perhaps the Russians at DST Global—might just believe this imaginary number. (It's hard to see why, though: DST got in at a $10 billion valuation in May 2009. Facebook's user base has more than doubled since then. So its valuation should…quintuple?) But concluding that Goldman Sachs believes in a $50 billion valuation is poor reasoning. As Salmon does point out, Goldman has likely earned the lead book runner slot in any initial public offering.
Consider a 20% sale of the company in such an event – or $10 billion at today's "valuation" – and a 2% underwriting fee of $200 million. Goldman would have to share such spoils, so let's call it $100 million into their pocket. Subtracting that underwriting fee from the Goldman investment, and you could easily make the case that for a net purchase price of $350 million, Goldman's ante only values Facebook at $39 billion. Hey, that's just off by $11 billion, so don't worry about it. Buy your shares where you can get them. In other words, go open a $10 million minimum private client account at Goldman Sachs. (Who says Goldman didn't learn its lesson about shafting its own customers? This time around, they've managed to get the customers to line up the shaft themselves.)
Reason #3: Zynga. For all the success of the largely-Facebook-hosted games of Farmville and Cityville, it's hard not to wonder what the success of the anachronistic game maker Zynga really means. Do people really miss their Atari that much? I doubt there's any crossover between the people playing Farmville and those playing the technologically advanced Call of Duty: Black Ops. Which is fine – to each his own. But all the Zynga games make me think about is Wal-Mart (WMT). Which is also fine – there's nothing wrong with being compared to one of the world's most successful companies. But here's the disconnect: if Facebook's future success depends on aiming for the lowest common denominator with the most people possible, that implies pretty slim margins a la Wal-Mart. You think they're going to justify a $50 billion market capitalization through banner ads? Are you kidding me?
Reason #4: The niggling details. Important question: Just what are Facebook's numbers? Important answer: Who the hell knows? In November, Zuckerberg told the world not to hold its breath for an IPO. No worries, Mark, because I'm not. Google (GOOG), if you recall, was pretty open by the end of its life as a private company – everybody knew what it was doing and how it was doing it. Facebook (and, in the same sense, Twitter) reminds me of Kozmo.com during the dot-com boom. Kozmo, you will recall, somehow had people convinced that they were going to make tons of money doing something remarkably pedestrian – that is, delivering Ben & Jerry's by bicycle to Manhattanites. (I remember sitting in the offices of Flatiron Partners way back when. Someone ordered some ice cream on the Web, and – voila! – half an hour later some delivery guy shows up. Kind of like what would happen if you called the deli on the phone. The future was ours to see!) Facebook reportedly pulled in $2 billion in revenues in 2010. I don't know about you, but I'm disinclined to pay 25 times revenues for anything, let alone a company the finances of which I know pretty much nothing about.
Reason #5: Warren Buffett. The legendary investor cautions those looking at outsize valuations to consider one's purchase of company stock in a different way than price of an individual share, whatever it may be. He suggests one look at the total market valuation – in this case, a sketchy $50 billion – and to consider: Would you buy the whole company for that price, if you had the money? The market value of Goldman Sachs is just $88 billion. I'd take more than half that company over the whole of Facebook any day of the week. I bet Warren Buffett would too.
More on Fortune.com:
Facebook-Goldman loser: IPO 'industrial complex'
Facebook's friend in Russia
Interesting comments. The main issue here is Revenue. Google gets 95% of their $4billion profit from Adwords. FB has advertisers salivating because you can target your ad dollar like a laser due to FB social data setup. Google is much harder to target your customer then FB and look what they are doing. FB is just getting started with advertising.
Facebook is a social networking fad. I've used it for 3 years now and I'm completely bored with it. It will fizz out in 3-5 years time if it does not venture into other markets and reinvent itself.
As a developer I'm amazed at what people set the value to facebook. I believe I could create a site just like it in weeks. I understand the argument they have lots of users but then again so did myspace and I don't think many people use them now. People should wake up and realize from a technoligical side there is nothing to facebook and there will be other sites competing with it I'm sure. I might even start creating my own facebook alternative if they're worth 50 billion.
The valuations for these web 2.0 companies is based on what...? And with a private company I'm EVEN MORE SKEPTICAL. Did we learn NOTHING from the 2000 blood bath? As McDonald says, what is this company's payload? Banner ads? Please... There is an old Saturday Night Live skit which has some of the players making a fake tv ad extolling the virtues of a company that made change. "We can give you change for any combination of denominations..." and etc. "How do we make money? VOLUME!"
Facebook has a huge user base. Great. Show where that's translated to profits from banner ads. If I'm wrong, I'd be happy to take into account its other revenue streams.
We will all be chanting the Facebook Creed sooner or later...
I love how so many people here never worked on Wall Street or in the VC/Angel investing space, and yet they are bashing this article, trying to preach to others how to value a company.
All Duff is trying to say, is that a $50 Billion valuation for Facebook isn't a good deal, unless you're GS who is going to be the IPO Lead Book Runner. Valuation of a late stage company like Facebook should be based on its ability to generate free cash flow in the future that can be reasonably estimated. Yes, Facebook has the highest traffic and its social graph that no other company has, but how much money will it reasonably make? Afterall, this is what a business is about. How will they maximize their profit per user that justify a 25x revenue valuation? Typical high growth internet companies are valued at 5x to 10x revenue at best. Anything beyond the ability to generate free cash flow is a wild guess, that you simply can't justfiy.
I believe Facebook's goal is to become everyone's "home base" for the internet. I think they would like you to get on the internet, log into Facebook, and do all of your searching, shopping, emailing, etc., from their site. If they can make this happen, then the sky is the limit.
Does Facebook make any money, at all? I don't think so. So a person views their facebook webpage 100x a year, do they spend any money there? No. Its bleeding money in bandwidth costs like you wouldn't believe, like Youtube. Lots of people of people are aware of the brand name, like Coca Cola, but in the end, its just rotten sugar water. The difference being every time you drink a Coke, Coke makes money. Everytime you return to your Facebook page, Facebook does not.
My Heavens! Are you my LONG LOST, TWIN BROTHER? I too wouldn't touch this fevered company, AND, we will NEVER have a facebook page.....WHO gives a damn? Seems people are so desperately whiney and needy....posting every break wind on 'their page??????'
Maybe Zuckerman IS TRULY a genius, and unlike the EVIL at Google, he's stickin it to the BIGGEST EVIL - GS? I DO aplaud Mark....GREAT JOB on BUILDING something that appears as necessary as Meth, to a mindless addict!!
Can you spell "Bubble?"
you are obviously a writer on a rant that has not done their homework. please do not misinform the public on just a hunch. social gaming sharing 30% of their profits with FB thru fb credits. That alone with the comparison to atari and walmart is dumb. do yourself a favor and stop writing.
nice
Too many over 30's using it....it is becoming uncool to the influential demographic. (And I belong to the over 30 side)
Next SNS step up please....
No tangible product, not a penny
Thank you Duff for this earnest analysis. I actually posted it to Facebook. I do not have $2 million laying around but if I did, investing in Facebook is not the route that i would go.
It doesn't matter how many people are using it now. The moment something better comes along, people are going to rush over to that new site like they switched from MySpace to Facebook.
Also, the adverts, programming, and data collection only really works if there's enough people on the site. If the amount of active users decreases to 1/3 of the current user levels then the attractiveness and usefulness of the site will decrease dramatically.
Well written. Hats off. People who understands acquisitions/valuation will think the same. I will rather buy Google or Appl or RIMM or HON - as much as I can with $50 billion
I agree. My company advertised on Facebook recently (kovalum.com). Total waste of money. Won't do it again.
Most of the arguments here are missing the point. There are no Facebook stocks for sale on the market to anybody. If Goldman wants to invest in a private company it's Goldman's right (or problem). But none of us (even with 2 mln laying around) can get in on this anyway. But I would agree with Goldman rather than the author.
While facebook would be a good investment for right now, it's not going to be one in the long run. The popularity of social media sites rely on fads and it wasn't too long ago that MySpace was the newest and biggest thing. I predict that Facebook has another 4-5 years before the next big thing comes out and goes the way of MySpace.
Anyone who buys into this will have to use a LOT of caution. There's the potential for gain, but not in the long term.
Finally, a reality check on the Facebook hype -- well done! I would add one more point - despite the hype, there really are no significant barriers to entry for competitors, and GOOG is going to enter the ring in 2011.
Facebook is the most transformational company of our time. The reasons given here don't ring tru for me::
1. Someone smarting then me is selling - At some point, shareholders always diversify. The same shareholders were selling at a $1 billion, $5B valuations, and so on.
2. Goldman doesn't invest in everyone.
3. If Facebook controls 25% of page views, they are likely to get 20%+ of all internet advertising over time. That's more than $20B in 2015. Advertisers go to where eyeballs are, and they are on Facebook. That doesn't include revenue for Facebook credits, the ad network, or the dozens of other businesses Facebook will spawn.
4. Lack of transparency - They could get a higher value with transparency, but no one is buying Facebook for the numbers today, they are paying for the potential of what it could be.
5. Warren Buiffett - Like any investor, I bow at Warren's feet. But he never bought Google. Buffett never bought Apple. That doesn't mean that they are bad companies, that's just not his thing.
Does Facebook have risks? Certainly. But they aren't really addressed here (e.g. government regualtion, competition...)
4.
This sounds a lot like the Time Warner, AOl partnership. There was no vision of things to come.
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