What you have to believe to value Facebook at $15bn

So it would appear that not only Microsoft stumped up $240 for 1.6% of Facebook, but so did 2 Hedge Funds. The thing is, Microsoft at least got an exclusive global Ad deal to (hopefully) amortise their spend, but one wonders what offset benefits the hedge funds got?.

Take Microsoft's deal first...assume 40m Facebookers, divide by $240m and that's c $6 (per user) to make net out of over say 2-3 years. If you assume that Facebook's mean user base is actually c 80m over those 3 years then its an even more sensible $3 to claw back. (Note though that no sooner is the deal done, than it appears the growth estimates are being reduced - caveat emptor)

So Microsoft are pretty likely to be (about) whole on their $240m, and if ever anyone ponies up more than $15bn they make a little profit on the deal too. And there is definitely a value to keeping Google out awhile longer - so not a bad play by MSFT.

In fact, if you look at the Microsoft deal you should deduct some of what they spent and allocate that to an Ad deal (and a Keep Google Out fund), so their real valuation of Facebook is probably way less than $15bn.

But the Hedge Funds - what do they get by propping up a $15bn valuation? It is hard to believe they have put in c $240m for 1.6% of the company each without strings attached (to yank it out - Hedge Funds are usually traders, not investors - what gives)...if so, then they are probably demonstrating top class "top of bubble" dumb money behaviour.

(Update - this article implies the Ad deal is actually highly loss making - now if true that definitely shows irrational exuberance from MSFT as well - makes the hedge funds look relatively sensible!!)

Here's why...you have to believe some "interesting" things to believe a $15bn valuation. Allow us a small bit of back of blog-velope calcs

Facebook has c $150m revenues, and is valued at $15bn - thats 100x revenues. Poor old Google has revenues of near $15bn and only a measly 13x multiple to its market cap of $190 bn. Let us make the heroic assumption that Facebook is just a tad overvalued at $15bn now, and its all based on growth - thus has to "grow into" its valuation, and that is more likely to be at the 10:1 ratio level

To therefore believe that FB is worth $15bn you first at least need to believe that it will very soon achieve at least 10x current revenues (Google not exactly being undervalued). This is of course a simple calculation:

(i) You can choose to believe that they can increase user base 10-fold (a mere 1/2 billion - thats about all the citizens of Europe and US that can click a mouse)

(ii) You can choose to believe that they can extract 10x more revenue per customer somehow - say $37 per person pa (today's 40m people over $150m revenues is c $3.75 per person). That is more believable, but is still a stretch if its only Ad based. Social Nets have very low CPM, on say $1 CPM thats c 37,000 Ads the average person needs to see, or (assuming you log in daily) about 100 / day - thats 100 pages you have to read, every day, at one Ad / page (thats Google plus levels of usage daily by the way). If you assume that the old SocNet ratio of 1 real visitor to very 10 registered users holds here, its more like 1,000 pages per user per visit to be read - or you can be hopeful that CPM's go up 10 fold too

But its not totally impossible to imagine a combination - say 100m dedicated users @ $15 pa (Just the entire US clicking population clicking away on only about 20 pages a day, every day, at $2 CPM) gives an annual 10x multiple.

(Most big Socnets get about 500 - 600 pages visited a month - Facebook is about thereabouts, but one assumes this will go down over time as the users force less "one page per function" navigation on them)

Or, do it another way - Google makes around $4bn (ish) net, so Mkt cap of $190bn / 4bn gives us a market cap / net margin ratio of about 45:1 - ie $45 of market cap per $1 of net margin. Lets assume Facebook gets about that ratio. I read that Facebook is expected to hit c $30m net this year, which on $150m is a c 20% net margin, and at Google levels implies a value of c 1.2bn (yes, yes, I know higher growth is assumed - but 12x ???). Let us assume when it grows up, Facebook's vital stats look roughly like Google, so when Facebook is worth $15bn, applying say a 50:1 ratio means a net margin of c $300m, ie revenues of $1.5bn.

Deja Vu....

(I assumed also that there are no economies of scale, +ve or -ve from 50m to 500m users - in fact I'd assume it costs more to go to customers across the planet in multiple languages)

But, thats not the end of it - the problem in business case build here is the transitory nature of any one SocNet compared (potentially) to Google, especially as they compete, commoditise and more vertical Nets open up (and Google has yet to play its hand). At some point investors will run the ruler over the free cash flow line (cash out x number of years of cash out), and that is a whole 'nother different issue.

Google's 45:1 ratio is extremely high by any standards, but you could probably believe they will be around 10 more years in current fettle or better. Can you really believe a SocNet churning out $1.5bn of revenues (given what we have to assume about users, CPMs etc to do that) is going to be around at that level for 10 years?

Lets say its real life is 5 effective years (for simplicity we will assume the top and tailing years at the agreed DCF is 5 effective years ) - that means dear old Facebook needs to be hitting either a market cap: net margin ratios of 100:1 (twice Google) when it grows up, or its revenues and net margins have to be at c £ 3bn and c $600m respectively.

So, can you believe all that?

If so, you can invest your $240m for 1.6% of Facebook....

If you don't, then you are probably an Angel fearing to tread where the foolish money seems to want to rush in.

(And you know what they say about fools and their money.....

(A post-cursive thought - Google, to whom $240m is also chump change, were clearly not prepared to bid at these terms and conditions so implicitly they do not value Facebook as $15bn - and since they are no fools, maybe the Facebook Hype community ought to reflect on that)