Deal Radar 2008: Facebook Woes Coming?

Facebook is the most popular social networking site providing an interactive space that helps members communicate with “friends”. The site features like ‘Wall’ and ‘Poke’ have created a vernacular amongst the youth population. It was started in February 2004, by Harvard student Mark Zuckerberg. “Are we Facebook friends?” has now become a social phenomenon!

Angel Financing of $500,000 came in September 2004 from Peter Thiel of PayPal fame. Series A financing of $12.7 million in May ’05 came from Accel Partners. A $25 million Series B in April ‘06 came from Greylock Partners and Meritech Capital along with previous investors. The series C financing of $300 million came in October ’07 comprising of $240 million from Microsoft for a stake of 1.6%, and the balance from Li Ka-shing, Marc Samwer, Oliver Samwer and Alexander Samwer. The Series C valuation was pegged at $15 Billion.

According CEO Mark Zuckerberg revenues for the year 2007 was $150 million and he projects a revenue of $300-$350 million for the year 2008. With an estimated Capex of $200 million (to go into servers) and a projected EBITDA of $50 million, the company’s estimated cash flow will stand at a negative $150 million.

As per Quantcast the website is ranked 16th and unique visitors in U.S. alone for December 2007 was over 35 million.

Rumors are floating that Facebook may strike a mobile deal with Nokia which would give them a greater space in the mobile web. Nokia may also take an equity stake in Facebook. There is another rumor that Facebook is set to acquire Plaxo for $100 million to $200 million.

So what is Facebook’s destiny?

Microsoft’s investment in the month of October 2007 was based on an estimated valuation of $15 billion. If we apply a 15X revenue multiple (higher than that of Google’s 11, and let’s assume for a moment due to its extraordinarily high monetizing potential), to the estimated revenue of $350 million, its optimistic valuation turns out to be $5.25 billion. Based on that we get an EBITDA multiple of 105, which is much higher than Google’s 29. Moreover, we may see valuation receiving a cold shower, given that even Google just missed its earnings because it is finding it difficult to monetize its social networking sites.

By any measure, $15 billion appears to be an exorbitantly high valuation.

No investment banker in their right mind would be willing to take Facebook public at this valuation. They could go for an auction-based IPO that Google popularized. But investors have to be really stupid to pay this astronomical value for a company that is still in its adolescence with an unproven road map for sustainable revenue and profitability (at that scale).

Would anyone buy the company? Most certainly not at that valuation.

Looks to me like Facebook has been frozen. By whom?

By two entities, to be precise. By Microsoft’s brilliant business acumen, and by Zuckerberg’s adolescent ego. Let’s look at each separately.

Microsoft has been looking at its own failure to compete with Google in Search specifically, and in Consumer Internet in general. Meanwhile, Facebook has materialized from thin air with the promise of changing the entry-point to the web from Search to Social Media. Facebook is the only company that makes the Google guys uneasy. They don’t quite understand what the ramifications of this phenomenon could be.

Microsoft thought to itself, “Google must not acquire Facebook. Neither should Yahoo. Let’s play to this kid’s ego, and by sprinkling $250 Million on the exercise, we can establish an artificially high valuation that would bring their options of exit down to zero.”

And they did.

On the receiving end, 23-year old Mark Zuckerberg was thinking, “I must be a real stud, I’ve now got Microsoft eating out of my hands!” If some adult at the investor table tried to mumble that this valuation may cause some problems, he was appropriately silenced by the euphoria of
the $15 Billion.

Now, Facebook is running up expenses, hiring like Google, riding high and mighty. Let’s see how long this lasts. As I said before, Facebook needs to back-fill the valuation to get out of this fix. If they can do so, the Facebook story would have a happy ending.

Otherwise, this will be a tragedy of Shakespearean proportion.

This segment is a part in the series : Deal Radar 2008

Comments

I may be a bit naive, but can you explain to me what is the fundamental difference between say an orkut, a myspace or a facebook ?

I see all of these to be the same. As also, except for handling scaling, I dont see much technology in there.

samir

Sam Tuesday, February 5, 2008 at 11:23 AM PT

[…] it’s not really news to a lot of people who have seen this space before. But Deal Radar has a post up today explaining how it’s quite probable that Microsoft outmaneuvered Google, Yahoo!, and Facebook, […]

Facebook $15bn valuation a cruel trick by Microsoft? Tuesday, February 5, 2008 at 12:13 PM PT

Another master stroke from the business strategists in Redmond.

If Zuckerberg is worth his salt,
1) he will reign in the operations and slow his cash burn and
2) he’ll become more realistic about the actual valuation of Facebook and guide his strategic moves accordingly.

To do this, he probably need a new CEO with a bit of experience to help guide him through uncharted waters.

Gates is so much smarter than Zuckerberg. I thought the same exact thing about Microsoft’s motives back at the time that Microsoft made that strategic investment in Facebook, while the numbers weren’t adding up.

Good call, SM.

I would rather bet on one of your oversold 3.0 plays like Netflix or Zip, than put 1¢ into Facebook at anything near $15B, especially after Google’s most recent earning report warning about social network monetizing troubles.

Mark wake up quick!!

Realtosh Tuesday, February 5, 2008 at 12:26 PM PT

Samir,

You have to get outside the nerd mindset to understand these. They’re like clubs. What is the difference between one club and another? Surely not their technology … may be the people who’re members of the club. May be the decor. May be the music. May be the food.

Sramana

Sramana Mitra Tuesday, February 5, 2008 at 3:25 PM PT

Interesting insight SM. Thanks !!

Balaji Tuesday, February 5, 2008 at 3:40 PM PT

Sramana:
May be you didnt get my point or may be I didnt
put it across properly.

I suppose it is not very well known why a certain social
networking site takes off while certain others dont
take off. In India for instance, orkut is big, and facebook is just about picking up, I suppose.

I agree technology need not be a differentiator, but just wondering if there are any studies made as to what makes a particular social networking site click.
Understanding the dynamics would be of immense
value, I think.

regards,
Samir

Sam Tuesday, February 5, 2008 at 9:46 PM PT

[…] Battle Plan, Masterful ManeuveringsMicrosoft has been on the roll, lately. First it froze Facebook, and now it has made an unstoppable bid for Yahoo! while the latter is struggling to regain its […]

Microsoft: Masterful Maneuverings - Sramana Mitra on Strategy Wednesday, February 6, 2008 at 9:52 AM PT

Hi Samir,

I haven’t seen any such study on social networking.
It’s a good question.

Sramana

Sramana Mitra Wednesday, February 6, 2008 at 10:20 AM PT

Hi Sramana,

Just a question. There’s one thing I don’t understand. When Microsoft pays 240 M for 1.6% stake. Isn’t that 15 B valuation only what Microsoft values Facebook at?

So if Zuckerberg agrees, what’s to stop another investor from buying Facebook for 5 B? Which would of course screw over Microsoft. And how does that affect Facebook’s IPO?

My apologies for being naive. I’m new to this community.

Thanks!

Darren Wednesday, February 6, 2008 at 12:22 PM PT

It depends on how the Microsoft deal is structured. Normally, yes. But Microsoft may have clauses in there saying that if another round of investment or an exit happens at a valuation below what they paid, they have to be accordingly adjusted.

I haven’t seen the termsheet, so I don’t know.

The bottomline is, this $15 Billion euphoria is artificial.

Sramana Mitra Wednesday, February 6, 2008 at 12:36 PM PT

[…] pointed you to their post because I’m not smart enough to explain the details […]

MySpace being played off of Facebook against Microsoft’s bid for Yahoo! Thursday, February 14, 2008 at 12:41 PM PT

Excellent insight. I think if Zuckerberg would have perhaps had a more seasoned executive staff that deal with MSN might not have gone through. His age and hubris will be the roadblocks of Facebook. Theres no questioning his talent and ambition.

Torq Tuesday, March 4, 2008 at 9:36 PM PT

you are so cynical. it is truly sad.

blinded by billions, you don’t seem to care that Mark Zuckerberg is an American original, a young man who has galvanized his generation and given them a voice like never before.

i hate to say it, but the reason most websites suck is because of your sort of bloodless analysis. you are so impressed with microsoft and yet nobody gives a rat’s ass about anything in their online portfolio that they didn’t acquire. the company is an online dud, and you think Z is afraid of them?

you aren’t even a little IMPRESSED by the boss strategy that led to the $15b valuation ? i can’t believe you. you’re like “no investment banker would EVER whine whine whine”. let me guess that you won’t be inventing any cool websites that capture the zeitgeist of an entire generation anytime soon !!!!

i’m sure you are a nice person, and let me bet you that Mark Zuckerberg is nice as well. You’re afraid of Steve Ballmer – don’t be. He can only acquire. Facebook – well they know how to create.

Srini Kumar
CEO
MetaNotes.com

Srini Kumar Wednesday, March 5, 2008 at 6:27 AM PT

neat analysis SM.

social media needs different marketing experitise and logic to sell advertising. google has been successful at selleing contextual advertising.

but a microsoft or a yahoo lag behind google in the contextual mappinp tech. but it could turn out the the old demographic ad targetting based on the geography and age group etc etc all that old economy jazz would be more appropriate to target the users of social media sites.

this might be a break for MS as they can tune their existing tech to target based on the above demographics.

ram seshan
cto
http://www.nautanki.tv

ram Wednesday, March 5, 2008 at 7:48 AM PT

Srini,

I am very appreciative of Zuckerberg’s achievement. And I know it is fashionable to blast Microsoft. But I also love business, and when I see a smart business maneuvering, I appreciate that too.

Besides, Microsoft’s achievement is no less. I don’t know how old you are, but there was a time when computers were a rare phenomenon in society, when a few young men – Bill Gates and Steve Jobs among them – came with the dream of putting computers on every desktop. And they did.

Sramana

Sramana Mitra Wednesday, March 5, 2008 at 11:43 AM PT

This is an indication of lack mentality…

Facebook is approximately worth $15B
and the founder Marck is now a Billionaire.

You become only a billionaire if you give
equivalent billion value to your customers
or the economy…

Facebook really gives that billion value.

Investors and Customers think that Facebook
value is $15B. They were the right ones to
value the company.

Free Traffic Thursday, April 3, 2008 at 9:35 PM PT

[…] […]

materials analyst Wednesday, July 23, 2008 at 1:27 AM PT

Good post. Who cares if Facebook and its founder are famous? Your post dealt with its valuation, and not who’s nice or innovative. Investors’ valuations at some point in time are strictly theoretical, because it’s one thing to put $250 million at risk and quite another to buy the whole enchilada for $15 billion. Also, notice that banks this year on the whole are valued at a whopping 73% less than they were a year ago. So much for snapshots.

It’s been often said that in the short run, the markets are a voting machine. In the long run, they’re a weighing machine. Facebook’s costs are on a rocket to Mars and its revenues are stuck in a traffic jam on the New Jersey Turnpike. Facebook needs to tell its users straight up: Our service costs money. We need to make a profit or go dark. The company must either go to a subscription model, or the $15 billion chimera will disappear faster than college boys can leave a party when the kegs run dry.

And that’s the way at should be. Anyone can fill a stadium by giving away tickets and concessions. There’s no genius in that. This is supposed to be a business, and IMHO Microsoft is indeed playing some smart poker. One poster criticised Ballmer as someone who can only acquire and not create. What the poster failed to recognise is that Ballmer has the ability and the resources to acquire…and to wait for the right price and the right time. That’s something that all the eyeballs in the world don’t give you.

Fred_in_Melbourne_Beach Wednesday, April 1, 2009 at 5:39 AM PT

Fred, You write well. I tremendously enjoyed reading your comments above. It seems, we see things the same way! Regards, Sramana

Sramana Mitra Wednesday, April 1, 2009 at 8:43 AM PT

[…] More Information on facebook on this excellent blog […]

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