The "$15 billion" nonsense
October 25, 2007
So Microsoft, under fierce pressure, cuts a complicated deal with Facebook that, among other things, grants the software giant expanded rights to serve ads on the fast-growing social network and requires it to inject $240 million into Facebook's cash-strapped coffers in return for a modest 1.6% ownership stake in the startup. Immediately, the capital investment is isolated from the rest of the deal, and we are told, through straight-line extrapolation, that Facebook is officially "worth" $15 billion. Reports the New York Times: "The investment values Facebook, which is three and a half years old and will bring in about $150 million in revenue this year, at $15 billion." Writes CNNMoney: "Microsoft Corp. announced Wednesday that it is investing $240 million for a minority 1.6 percent stake in Facebook, a price that values the social networking site at $15 billion." TechCrunch's Michael Arrington, putting the news into "perspective," throws together a chart that shows that Facebook's $15 billion "market cap" makes it the "5th most valuable U.S. internet company."
Welcome to Fantasy Island.
Extrapolating Facebook's true worth from Microsoft's investment is a ridiculous exercise, for two main reasons. First, the investment is part of a broader deal, the details of which are unknown. Clearly, Facebook needs cash to support its growth, and the cash payment was a price Microsoft had to pay to nail down the partnership. It has to be seen in that light, not as a market-cap marker. Second, and more important, Microsoft's investment is not financial but strategic. The company is currently engaged in a multi-front competitive battle under conditions of great uncertainty. Facebook forms one of the fronts, and partnering with the company is far more about gaining future strategic options and blocking the advance of a competitor (Google) than about making a financial gain through the appreciation of Facebook stock. Microsoft, in other words, is about as far from being a dispassionate investor as you can get. Its investment, in isolation, tells us very little about the true worth of Facebook.
Of course, the "$15 billion" number could become, in the near term, at least, a self-fulfilling prophecy by turning into the mental anchor for other estimates. But that's another story - and hardly a more rational one.
The story is not in facebook's valuation -- we're all clued into how bubbles create extended values. The real story here is as you point out: This investment says more about Microsoft than it does Facebook -- clearly Microsoft believes that collaborative social software could disintermediate their current business. Their server software may be growing rapidly, but their client software still makes a lot of their profit. Do enough people realize that big ol' Microsoft is getting ready to make a gymnastic jump in their core business? Do CIOs understand what this implies for their IT budgets 3 years from now?
Thank you for this excellent post! I was expecting this observation from other places, and am shocked nobody pointed it out yet (well, not really shocked).
Microsoft would have done that deal for 0%, and facebook probably insisted they take a token stake so they could parade that valuation number around. So slick. So smart. And everyone is playing along as excpected!
Thanks for this bit of sanity, Nick. FWIW - I did some quick math to figure what kind of earnings a hot tech company like Facebook would need as a public company to justify a $15 billion valuation. Answer: $270 million, assuming a forward PE of 56, which is what Google's was shortly after their IPO. I doubt Facebook, with $150 million in REVENUES, and virtually no profits yet, is gonna get there by the end of next year. VCs I know generously value Facebook at $5 billion.
Posted by: fred vogelstein at October 25, 2007 03:39 PM
@fred -- 2 quick questions if you'll indulge.
1) Where do we get this 150M revenue figure? There are no official FB financials, so I'm wondering where you get them.
2) Using your approach, a 5B valuation would require 90M profits, and if they can do that, what's to stop them from doing 270M? In other words, if you believe 5B, you can believe 15B, and maybe more!
Valuing a company based on earnings alone (or revenues, or any other single metric) is like valuing a person's health by his/her blood pressure, temp., or weight alone. Financials are complex, and the only people who really can attempt to value facebook (classically) are those who have seen (audited) financials. And even then it can get tricky (e.g., what if all 150M came from one customer?). And I might be tempted to throw classical valuation techniques out the window anyway.
Facebook is brilliantly manipulating their whole valuation process by press release and innuendo. Like click fraud, it's not even illegal! Time will tell if it's as profitable.
Nick, it wasn't the analysts and journalists who made the extrapolation. The very first sentence in the press release includes: "Microsoft will take a $240 million equity stake in Facebook’s next round of financing at a $15 billion valuation."
I would agree, tho, that Microsoft would value it's portion higher than other entities who would be getting merely a financial investment. That's why it will be interesting to see if there are any non-strategic investors in this "next round of financing".
Nick, I totally agree. This is nothing more than a strategic royalty payment to secure global exclusivity for their ad network. Any valuation that is extrapolated from this is fanciful and frankly detrimental to the average startup entrepreneur who now has unrealistic valuation expectations for their business.
With that in mind, Microsoft's own market cap grew by the amount of 2x Facebook's imaginary valuation in after hour trading. Puts the value in context for me.
Keep making us think.
Posted by: MosaicCFO at October 26, 2007 09:33 AM
From WSJ today - "Microsoft's 23% boost in net income, reported after the 4 p.m. close of markets, lifted its shares more than 10% in after-hours trading, making America's third-largest company by market value some $30 billion more valuable". The Vista cash cow is kicking in but MSFT needed a bit of new media relevance perception as well. That's a bonus on top of the Ad deal. MSFT may even have had Liquidation Preference meaning that $240m investment is no more at risk than the rest of their cash hoard in TBonds.
The question is would a purely financial investor pay that valuation? I don't think Warren Buffett would but TC is reporting two Hedge Funds putting in $500m. Stranger things have happened!
Posted by: bernard lunn at October 26, 2007 10:01 AM
100% agree with you, Nick.
But it is not surprising that the press is mentioning the $15 billion "estimated" value of Facebook. Big numbers always attract more readers, and talking about $240 million (albeit for only 1.6% of the company) isn't as impressive when you compare it to, say, the $1.65 billion YouTube acquisition.
Posted by: Laurent at October 27, 2007 12:58 PM
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