/ 5 January 2011

Is Facebook really worth $50-billion?

We're pretty used to hearing outlandish valuations on internet companies that, if they were people, would be barely out of nappies.

We’re pretty used to hearing outlandish valuations on internet companies that, if they were people, would be barely out of nappies. It happened during the first dotcom boom, and it’s happening again now. But news that Facebook is now “officially” worth $50-billion made even the most seasoned cynics choke on their lattes.

How can a seven-year-old company be worth that much? Simple — Goldman Sachs (the investment bank) and Russian technology giant, Digital Sky Technologies (DST), are investing $500-million in the company in exchange for 1% of its shares. So it follows that 100% of its shares must be worth $50-billion.

Or does it? Despite all these superheated shares fizzing around Facebook is still a private company. All of these trades are in what the investment trade coyly calls “secondary markets”. This means that, unlike a publicly listed company, Facebook is not obliged to report its earnings to the market.

Goldman is planning to sell another $1,5-billion worth of the shares to its own clients in the next two weeks, and so it has been talking the stock up. Reuters reports that a potential investor “believes Facebook has $2-billion in revenues, though the person does not know if the fast-growing company is cash flow positive or profitable”.

Even if all of that revenue were profit, Facebook stock would be worth 25 times its yearly earnings — a measure known as the “price/earnings” or PE ratio. It’s far more likely that their real earnings (after costs) are around $500 million, which would make their PE 100. Given that a PE of 20 is considered high, 100 should give investors pause, since it implies that it would take 100 years (at current earning rates) for the company to ‘pay back” the investment in its shares. And that’s assuming Facebook is, in fact, making $2-billion per year and $500-million in profit — again it’s under no obligation to tell anyone the real numbers.

Another way to look at this valuation is in terms of Facebook’s bread and butter — its user numbers. At the moment it has just shy of 600-million active users around the globe (that’s twice the population of the United States). This deal means that investors are effectively paying about $83 per user.

That seems like a lot until you consider that each time an advert is clicked in Facebook it earns them around 60 US cents. So it would take 133 clicks from each user to earn that back. I know what you’re thinking: I’ve probably only clicked on a dozen ads in my entire time on Facebook. But advertising is only one of their revenue streams.

Games like Farmville and Mafia Wars earn Facebook hundreds of millions of dollars per year. Some players literally spend a hundred dollars a month on their virtual farms and crime empires. All Facebook needs is a couple of million of those users — less than 1% of total players — and its 10% of the way there.

And then there’s future growth. In September 2009 Facebook had “only” 300-million users — now it has nearly 600-million. Facebook executives don’t even blink at the idea of a billion active users — they expect it. If we assume they have a billion users by the end of 2012, then Goldman and co have really paid $50 per user — or 83 advertising clicks over the entire history of each user.

Even so, without seeing their earnings in black and white Facebook remains a gamble. Sometimes, like Google with its PE of 25 (that was once as high as 50), the gamble pays off handsomely. And sometimes like Webvan, an ill fated casualty of the dotcom bust, the gamble goes spectacularly wrong.

But given how much scorn was heaped on Facebook by market analysts when it refused a $1-billion offer from Yahoo! in 2006, you can forgive its shareholders for not taking our opinions as gospel.

It makes you wonder about three-year-old Twitter, recently valued at $3,7-billion. The analysts are saying all the same things about the micro-blogging giant as they were about Facebook back in 2006: no business model, unsustainable growth and opaque earnings reports.

Perhaps the most unlikely winner out of this deal is homegrown media giant Naspers. They own 28,7% of the Mail.ru Group (previously DST Limited) who in turn own 2,38% of Facebook. That means Naspers effectively owns around 0,83% of Facebook — worth about R2,9-billion at today’s exchange rate.

Interestingly DST Global, a separate entity in which Naspers has no significant holdings, already owns 10% of Facebook. This new tranche takes their investment to about 10,5%.

Of course that number is trivial by comparison with Naspers’ 35% stake in China’s Tencent — a social media company currently valued at $42-billion on the Hong Kong stockmarket. Tencent’s main brand, QQ, passed the half a billion users mark years ago and is still growing. Suddenly $50-billion doesn’t seem that ridiculous anymore.

  • A previous version of this article had two factual inaccuracies. Firstly, it implied that revenue equated to earnings, and therefore gave an incorrect definition of the PE ratio. Secondly it stated that Naspers now owns 3% of Facebook when in fact, due to ownership structures at DST, it only owns 0,83%. We regret these errors.