From a reader: “What do you mean by Redmond outsmarting Facebook in your post and that the $15 billion valuation will come back to haunt them?
By Redmond, I mean Microsoft, of course. There are a couple of statements in my sentence, the first one being that MSFT outsmarted everyone and the second one being that Facebook will one day regret the deal.
WHY MICROSOFT OUTSMARTED OTHERS
MSFT is not an investment company, it really could care less:
a) what valuation was attributed to Facebook and
b) what stake they have in the deal they just made with the social networking site.
MSFT did this to block Google much the same way Google paid MySpace and other Fox Interactive Media sites $900M: essentially to block the competition. Had Yahoo! or Google done the investment, MSFT’s ad deal with Facebook would have been severed for a mere $10M fee, MSFT would have lost a large chunk of its non-MSFT inventory and it would have further trailed Google and Yahoo! in search and online advertising.
So we know why MSFT needed to do the deal. Of course, the alternative was an outright acquisition or a hefty investment. Up to the deal announcement, rumor was that MSFT (or the “winner”, whomever that would be) would have to fork over $500M to $750M. That’s a lot of money. To put it into content, all of MySpace and parent Intermix was bought for $580M, my old employer IGN Entertainment was acquired for $650M.
The point is $500-750M buys empires, $240M does not. So for “only” $240M MSFT effectively bought a call option on Facebook giving it the right - but not the obligation - to buy Facebook in the future. Of course, it was not really a call, because even if MSFT wants to buy Facebook, Facebook does not have to sell. But, the upside is that this option does not carry a strike price (the pre-determined price that the holder of the option would have to pay to buy the underlying asset, in this case, Facebook).
If Facebook grows to become the next Google (I’m not convinced it will, because social networking is not search from an economic perspective at all and fanboys really need to wake up and realize this little fact), then MSFT can get some added value from their stake. If Facebook does not grow to be a money machine, then its valuation in the future will remain close to the $15B it got… if MSFT wants to buy it, it can. Don’t forget, eventually Facebook’s investors will want their money back… and their options are now limited to an IPO or a sale to MSFT. An IPO won’t really work, we’ve outlined that before, but the reason is simple: public shareholders will find better financial returns elsewhere in publicly traded online firms.
I think the $240M for 1.6% on a $15B post money valuation had everything to do with the lower investment MSFT wanted to make, Facebook’s desire to hit $15B in paper value and probably, the amount that Facebook investors were willing to dilute.
Yahoo! too could have paid a mere $240M, that is actually an amount Yahoo! could have forked over (though not really the $500-750M) but with MSFT already in bed with Facebook, this deal was MSFT’s to lose, and not Google or Yahoo! to gain. The flip side of why Facebook preferred a deal with MSFT was due to Facebook CEO Mark Zuckerberg desire to surpass Yahoo! and Google, leaders in display/banner online advertising and search. MSFT, in its current incarnation, is not a competitor to Facebook, it remains a software company… so Facebook sees its relative strategic value as being greater to MSFT. Facebook played this card well, but by getting a $15B valuation without actually hitting the cash register, it might come back to haunt them. Which takes us to the second statement.
WHY THE DEAL WILL HAUNT FACEBOOK
The implications for Facebook are simple: they will never want to do a subsequent down round, so any future investment will have to come in at a valuation greater than $15B which is not obvious, especially when you consider that current yearly revenues are $150M and $30M in profit. That implies 100x sales or 500x profit. This might pass when you are growing like crazy, but:
- if that growth rate slows down, or
- MySpace continues to grow as it has (which is rather ferociously), or
- Google actually does something with their OpenSocial strategy, or
- Facebook turns off users with their “let’s monetize users” strategy, or
- difficulty in trying to develop a business model, or
- people get tired of fb app overkill
- or frankly the reality that social networking will remain bottom of barrel ad inventory…
Then Facebook is in trouble. With its ferocious headcount growth, Facebook’s $240M won’t go as far as they’d like. even with an additional $60M, that brings the total warchest to $300M ($340M since inception). That is a far cry from the $500-750M it sought to raise.
Moreover, Facebook is a global phenomenon, yes, but its long term success abroad is anything but established, hence the rumor that Facebook was about to part with 33% of their funding to buy a Chinese social network site with a 10M user base. China, 10M… what is that, like 1% of the population.
Anyway, long term, few companies will be able - or want to - acquire Facebook above $15B… and an IPO will remain the only opportunity. But, in an IPO, seldom do investors and founders totally sell their holdings… so while they might IPO at a high price, their subsequent stock price can falter… and I think with its current financial profile, it probably will.
Of course, they said that about Google, too, at $85/share… but Google was printing money by the time of its IPO, so it’s very premature to talk about that with Facebook.
Ultimately, even if someone else, say News Corp., Google, Yahoo! were to approach Facebook about a sale, MSFT can simply get involved in the process to bid up the price enough to scare away others, leaving Facebook with no one to poke.
In fact, this is why AOL has been a hard sell. Even when Yahoo! or MSFT show an interest, Google’s 5% for $1B on a $20B valuation comes back to haunt them.
Tags: Facebook.com, Uncategorized|
Posted By: Ashkan Karbasfrooshan | Nov 30th
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