Title: Did Microsoft Overpay for it Facebook Stake?
Date: May 9, 2008
Source: NY Times
Theme: “Microsoft also got exclusive rights to run banner ads on the site in the United States through 2011”
Author: N.A.
Did Microsoft Overpay for Its Facebook Stake?
This week’s chatter that Microsoft may have approached Facebook to discuss a possible takeover has created quite a buzz. But maybe Microsoft should be inquiring about getting a partial rebate on its $240 million investment instead.
Microsoft’s October purchase of a 1.6 percent Facebook stake implicitly valued the social-networking Web site at $15 billion. Even at the time, some people questioned such an eye-popping valuation. But as the months have passed, the number is looking even more bubbly. And not just to us: Several Web sites this week have questioned the value implied by Microsoft’s Facebook deal. On Friday, PEHub’s Dan Primack suggested it might be “one of the worst venture capital deals of all time.”
First, a big caveat: It’s hard to gauge how much Facebook is worth using traditional methods, because it is not a public company and gives out little in the way of performance data.
One way to measure its progress is to look at how fast it is growing, and things look upbeat on that front. Facebook had 109 million unique visitors in March, according to Comscore. That is 2.5 times as many visitors as the same time last year.
Facebook’s founder, Mark Zuckerberg, said in a conference call to employees in February that the company had revenues of $150 million last year and expects to bring in twice that amount this year, or about $300 to $350 million, an increase that is roughly in line with the rise in users.
So it’s clear that Facebook has grown. But growth is only part of the story. It needs to make money, something that has eluded it so far. Mr. Zuckerberg has said he expects the company’s Ebitda, or earnings before interest, tax, depreciation and amortization, to be $50 million for the year. Subtract the $200 million in planned capital expenditures, and the company has a negative cash flow of around $150 million.
That would be just fine if it continues to expand rapidly, and the outlook for social networking remained stellar. But there are a few signs that things are slowing.
First, News Corporation revealed Wednesday that its social networking site, MySpace — which has more users and three times as much revenue as Facebook — missed revenue expectations and actually took in 10 percent less money than in the previous quarter. For a genre that is supposed to be growing like gangbusters, any contraction in revenue, even with a slowing economy, could raise questions.
But that’s MySpace: What about Facebook?
The Valleywag blog, in a recent post called “Finally, the Craplets on Facebook Begin to Fall,” described an apparent decline in interest in building and installing Facebook applications.
Why is this important? One reason that people have been so excited about Facebook was b
ecause it opened up its network to third-party developers to create little tools and games for its users to install and play with — even though many of those “apps” seem to have little purpose, and it has never been entirely clear how they would translate into riches.
Now, some see signs of app fatigue. The number of posts in the developer page on Facebook’s official developers’ forum is down 27 percent from January to April of this year, Jesse Farmer recently said on his 20bits blog. The usage of new applications also seems to be down.
Henry Blodget, the former Internet analyst, also suspects that Facebook’s star has fallen a bit since October. On his Silicon Alley Insider blog, he argues that Beacon — a Facebook feature intended to allow advertisers to exploit the connections between friends — has essentially “flopped” after generating fierce resistance from Facebook users.
Factor out some of these fancy features, and it may seem as if Microsoft overpaid (although we would add that $240 million is basically loose change for this software giant, which was prepared to spend $44 billion to buy Yahoo).
Which brings us to this admittedly rough comparison: Yahoo’s market capitalization is now about $35 billion. With about 506 million unique visitors in March, that translates to about $71 per visitor. Apply that same metric to Facebook’s 109 million unique visitors and the company would be worth $7.7 billion, about half the value implied in the Microsoft deal.
Fans of Facebook may contend that it would be folly to value this growing business based off its current performance and limited data. Its 40 million user profiles are a marketer’s dream and have yet to be tapped. Even if the number of users remains constant — which is highly unlikely — Facebook could make millions of dollars selling marketing data to third parties. Its user base is older and richer than other social networking sites, so it could potentially bring in significantly more ad revenue than its rivals.
And another point: With its investment in Facebook, Microsoft also got exclusive rights to run banner ads on the site in the United States through 2011. Maybe to Microsoft, that made it well worth overpaying for the stake itself.
Comments
May 9th, 2008
What people fail to realize is that this is a strategic investment not a financial one. Microsoft is not a venture capital firm and doesnt need to see the same returns, they only need to insure that the 240M sees the same IRR as the rest of their cash and cash equivalents do, possibly only 6-10%. That goal could easily be achieved through liquidation preferences and or other financing terms that would guarantee them a certain rate of return which Facebook’s current operating and financial would support, but still be considerably below the 15B valuation.
— Posted by r goldberg
May 9th, 2008
One reason there are lesser facebook apps is app builders are too busy adapting existing facebook apps to Myspace and Hi5 using the Google Social API. Two top games are now on both myspace and FB(triumph) and dopewars online is on hi5 and FB.
A lot of people used FB more for gaming than for social networking which anyways is much better on myspace.
However the new Fb features like live chat, and steps to counter app spam seem to be working, and its only till they get the ad monitization right, which even google found some time to think over (and is still thinking over for you tube etc)
FB application buiders need to generate money too, and they can do that if they run application across multiple social networking sites. My guess this sector is ripe for mergers and consolidation. The 71 dollar per user figure for yahoo and 140 dollar per user is just plain nuts considering how fast websites like myspace and yahoo become old from hot and happening.
May 10th, 2008
Most of you do not understand how venture valuation works. $15 billion valuation doesn’t work exactly the way most of you are thinking about it. For instance, if Facebook sold tomorrow for only $1 billion (one billion), MSFT would make money on their investment. How’s this, you ask?
It is called a liquidation preference. Every venture deal has it. This means that in the event of any sale (other than a public offering), all of the investors get their original investment back first according to the liquidation preference, and then the remainder of the sale price gets divided pro rata according to the percentage ownership.
So if Facebook sold tomorrow for $1 billion cash, the investors would receive all $450 million of the cash that they have invested, and the remaining $550 million would get divided based on the percentage ownership (MSFT would receive about 1% or $5.5 million in addition to their original investment.)
Now, what do you think the chances are that Facebook would sell for less than $1 billion? Close to nil. So the risk of losing principal is very little for MSFT. In addition, they got the advertising rights.
Please remember to factor in that all venture investors have liquidation preferences when thinking about valuation. A company can be sold for less than its post-money valuation with the investors still making a profit.
