We learned this week that Facebook has turned 50 – certainly not 50 years old – I wonder if Zuckerberg’s parents are 50 years old – but worth $50 billion, or at least that’s the value implied by the sale of a portion of its (privately held) stock to Goldman Sachs, which will own $450 million worth of the company, and a Russian company, Digital Sky, which added $50 million to the $700 million it owns in Facebook already.
If there was ever a time to sell a piece of Facebook, it’s now. Zuckerberg was just made Time’s Person of the Year – which prompted by new favorite satirist, Andy Borowitz, to applaud Time’s controversial decision that Zuckerberg was, indeed, a person – and the movie is going great guns, even if I’ve never seen it (although I’m told the novice actor given the part really nails Larry Summers – I thought the part really belonged to Gary Shandling). And we only recently learned that Facebook has now surpassed Google as the most visited site on the American Internet – about 9 percent of all site visits in the U.S. go there, although Google would account for 10 percent of you added in Google’s e-mail and YouTube affiliations. So Facebook is the Flavor of the Month, and if you think having money makes you immune to that kind of faddishness, I have mortgages to sell you.
Is Facebook really worth $50 billion? I don’t mean that in the cosmic shake-your-head-and-bemoan-man’s-fate sense, but in the down-to-earth context of whether this valuation is for real. The answer is more yes than you’d think.
The first perspective on this question is – who are the investors in question?. And when you think about Goldman and the Russians, it’s not an open-and-shut case. Digital Sky added incrementally to its already existing holding, so they have some incentive to create a demonstration effect that makes their existing stake in the company look more attractive. And since Facebook is not traded public in markets and therefore subject to the information disclosure requirements and open trading procedures the stocks you own are, it’s easier to try to manipulate its value. That’s not to say it would work, but you could try – Facebook’s limited number of existing shares are traded in a private market in which former employees and angel investors can buy and sell, and that means there’s limited liquidity and nebulous price revelation, as we economists like to say, which means you can’t really be sure what the hell it’s worth.
As for Goldman, I’ll pick that up in a moment. To get there, though, start here:
One issue raised by the Facebook valuation is whether the company will go public. Some analysts see this sale as a teaser to goose the market and get the public ready for an offering in the near future. Others take Zuckerberg at his word – or his mumble – that he’s not interested in ceding that much control, and see this sale as proof that he can raise enough money to finance whatever plans he has without a public offering. The reasons not to be become a public company boil down to the transparency it requires – you have to reveal your financial information and tolerate a distracting debate among investors, analysts, journalists, and idiots such as myself as to the extent to which you can differentiate your rear end from a hole in the ground. And while the regulation of securities has been proved by history to be an essential part of a well-functioning capital market, it’s no picnic for the regulated.
The reason to go public is to raise money, a problem Facebook obviously doesn’t have. Moreover, it’s possible that Facebook and Goldman are showing us the first inklings an alternative to the public markets for raising large sums of capital. To wit: the Securities and Exchange Commission will allow stock in a company such as Facebook to be traded privately – that is, without the disclosure, governance, and other requirements made of public companies through laws such as Sarbanes-Oxley – so long as they have 499 or fewer shareholders. That’s a pretty tight limit. But Goldman is said to be considering a new investment structure in which it would buy Facebook’s private stock and then allow investors to buy shares of something like a “Goldman-Sachs Facebook Trust” or some such with a minimum participation of $2 million per investor.
That gets me back to Goldman and the valuation. I think Goldman sees itself as a competitor, down the line, to the New York stock Exchange – not for schleps such as, say you and me, but as a market-maker for big block institutional traders. It’s already in that business in a big way. And if it were to do so, the line between public and private companies would blur, since both would be traded behind Goldman’s closed doors, instead of in the more regulated environment of the NYSE. Regardless, Goldman’s interested in both private and public issues, and the idea of a Facebook structure in which it “owns” the stock and that it passes along all the goodness and badness of ownership to customers who don’t actually take title to the stock, has to be an intriguing one to a company with that kind of aspiration – it’s like a little Facebook stock exchange. Moreover, for Facebook, it’s a way to create liquidity without having to comply with regulations that require it to be forthright about its circumstances, which is its right unless it wants to come to public markets. As for whether I’d feel as protected in that arrangement as I do in a regulated, public exchange – well, I wouldn’t. But that doesn’t mean it wouldn’t fly. And Goldman’s buying into the company could be a step towards that kind of arrangement, or at least Facebook’s participation in it. So Goldman’s buying Facebook at a $50 billion valuation could be like the Nationals giving Jayson Werth seven years – OK, there’s a risk we overpaid, but it gets us closer to a strategic goal, so what-the-hey.
But there’s then the question of Facebook’s intrinsic worth. An interesting piece by an analyst named Andy Zaky, last August, made the case for a $50 billion Facebook, months before it actually traded at that implied valuation. http://seekingalpha.com/article/222076-the-case-for-a-50-billion-facebook His argument, if I may distill it, is this. Right now, Facebook doesn’t bring in much money, certainly in proportion to its user base; Zaky used the number 500 million users, but that was last August. It’s closer to 600 million now. And Facebook now has roughly the same number of visits as does Google, and Google’s worth $200 billion (in a public market). So if Facebook gets better at monetizing itself – primarily through advertising – there’s no reason why it can’t get close to valuations like Google’s.
I see one strong and one weak argument buried in this chain of reasoning and, one argument that Zaky’s analysis misses, or at least seems to from what I read into it. The strong argument is that Google became a dominant site through innovation, while Facebook became one through…well, what’s the technical term for bullshit? Ah yes…network effects. A product has network effects if its value increases the more people have it. Like the phone system, Facebook is more valuable to me, the individual user, if more people join me in using it. Sure, it’s more inviting looking than competitors such as MySpace (which was the most visited site in America as recently as 2007 -- Hey? How’s MySpace doing now?), http://www.telegraph.co.uk/technology/myspace/8130097/MySpace-surrenders-to-Facebook-in-battle-of-social-networks.html but the real driver is reaching the network-based critical mass that generates the value to the individual user. Google, in contrast, got where they are by doing something very well, there’s no network effect behind it. Its value as a search engine has nothing to do with how many other people are using it. There are a myriad of questions about Google’s algorithm, about whether Google’s conflicted in its role as an “impartial” search algorithm and, at the same time, a purveyor of other services for which people search, and there are privacy issues(which they share, in some respects, with Facebook). But it’s possible to imagine that Google might one day face competition from someone who out-Googles them, that is, does the search job better. If Facebook is somehow out-competed, it will be because hundreds of millions of people were so pissed off at them for whatever reason that they switched to another, comparable service. Absent an ergotistic spore breaking out in Facebook’s headquarters, that’s harder to imagine. Google sits on top of a network; Facebook is a network. So that’s the strong argument for why Facebook out-survives Google.
The weaker argument, as it pertains to Zaky’s analysis, is that advertising is about selling people things, and Google’s clientele are people looking for things, as opposed to Facebook’s users, who are looking for each other. Advertising is relevant in the extreme to the value Google creates for its users, but only incidental to what Facebook’s users want. I can’t imagine that Facebook qua Facebook is going to be worth as much – in terms of ability to generate revenue per user or per visit from its core service – as is Google.
But Google’s valuation, to my thinking, isn’t completely, or really, about their value as a search engine. It’s about their value as a gateway into the tangled maze of value created on the Internet. Google is a search engine, but it’s already failed as an equipment manufacturer, succeeded as an e-mail provider and originator of operating systems for equipment, and could end up being everything from a travel agency to a television station to a carriage provider, a wistful vision to which it occasionally purports to subscribe. Facebook hasn’t added this kind of dimensionality, but it’s going to – yes, I said, will – because something to which so many people feel allegiance and are involved with daily cannot help but evolve in that direction. It will own a generation of users in a way Google cannot, even though Google, their monopolistic hearts, does something.
That’s the issue I have with the Zaky analysis, the argument he misses, as does any other valuation that focuses on advertising revenue per view. Just what market are Google and Facebook in? They’re monopolists in their own bailiwicks, but the spaces they occupy are only islands in a larger archipelago of value on the Internet. They might be “service” or “software” companies, but that misses the point. If it turns out that Facebook can truly cement the attentions of a generation of (self-absorbed, to be sure) users, then they can dominate the decisions about what equipment gets used, what broadband providers area selected, what other services enter the Internet space. Is Facebook something you “get” on your mobile or broadband provider? Or is your mobile or broadband provider someone that lets you “get” Facebook? The difference comes down to who will capture the lion’s share of the value you realize by having the entire package – access, device, services, applications, the whole “stack.”
That’s why it’s possible to talk about Facebook’s being worth $50 billion – because it might end up, with all its gruesome banality (who gets to light the pyres that reward the villains who gave us Farmville or Mafia Wars?), the gateway to the broadband world. There’s some chance that one day, all broadband access, service, and device providers will have to dance to their tune.
Today, 500 million users. Tomorrow, the world.
January, 2011
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