Novice Investing - Facebook Poker Face

Date: Sunday 20th 2008f July 2008 12:38:58 PM

Facebook Poker Face - 10/25/2007

By: Hari Wibowo

Latest news regarding Facebook is that Microsoft will pony up $ 240 Million for a 1.6% stake (it is not a misprint, one point six percent) of the whole company, giving it a staggering valuation of $ 15 Billion. Less than a year ago, Facebook rebuffed an offer of $ 1 Billion from Yahoo to buy the whole company. This deal clearly is a victorius one for Facebook founder, Mark Zuckerberg.

Facebook value has risen rapidly in recent month as it opened up its platform to programmers. Last year, we felt that Facebook is overvalued at $ 2 Billion based on visitors' count at Alexa. At the time, Facebook had attracted 5450 per million visitors. Latest visitor count shows that Facebook had attracted 40,000 per million visitors which if we have done it right, would warrant at least 8 fold valuation than last year's.

First of all, let me congratulate Facebook for getting it this far. It has rebuffed a seemingly attractive offer and was forced to raise $ 25 Million from venture capitalists. Venture Capitalists are run by the smartest individuals in the area and I am sure they are demanding quite a lot of stake from Facebook. (If you assume a paltry 5% stake, then Facebook was forced to sell itself for $ 500 Million). We never did quite like the justification of the deal then and we do not quite comprehend it now. Sure, visitors have gone up 8 folds and that puts it at around $ 4 Billion now. This assumes that the last valuation was reasonable, and it was not.

I always believe fair value is when the return generated by your business is at least equal to the prevailing interest rate. For safety sake, let us assume 5%. Inverting it will give you Price Earning Ratio multiple of 20. To justify the price tag of $ 15 Billion, Facebook needs to book $ 750 Million of annual profit. Latest annual revenue estimate for Facebook is $ 150 Million. We will use a net margin of 30% which is what giant such as Google and Microsoft are reaping. Also, we will assume that Facebook will grow its revenue by 100% annually, which is a rather hard to reach feat.

Year	Revenue	Net Profit
2007	$ 150 M	$ 50 M
2008	$ 300 M	$ 90 M
2009	$ 600 M	$ 180 M
2010	$ 1200 M	$ 360 M
2011	$ 2400 M	$ 720 M

By 2011, Facebook has just reached its fair value of $ 15 Billion, assuming it can grow 100% for the next five years. Would you want to wait four years to buy overvalued company? Yes, you can talk about how Facebook is going to change the world with its new platform but even the AOL Time Warner merger looks like it is going to change the world during the frenzy. Let's look at it this way. Currently, Facebook attracted 4% of internet traffic according to Alexa and they are generating $ 150 Million. By 2011 when they generated $ 2400 M, assuming that they are twice as efficient to paste all their pages with advertisement or charge their users with subscription fee, Facebook would attract about 32% of internet traffic. That is about as high as the amount of traffic google would generate. And we are merely talking about social network here. And yes, there are a lot of other internet surfers out there who would not use the web to socialize. Even youtube which attracted 17% of traffic was acquired entirely for less than $ 2 Billion in 2006.

Having said that $ 15 Billion tag is way too high for Facebook, now we are still left pondering about Microsoft's intention of acquiring a small stake in Facebook. Microsoft already had some advertising partnership expiring in 2011 with Facebook and thus it is not in a dire need to act soon. Furthermore, does Microsoft think that it can create significant influence by acquiring a 1.6% stake of Facebook? A waste of money in a bucket, I think. If other potential acquirer (say: Google, Yahoo! or Ebay) is interested in acquiring Facebook, they would have to unwind the messy advertising deal made with Microsoft. Thus, for Microsoft, they are still assured their stream of revenue from Facebook. Perhaps, Microsoft is better off to throw another huge dividend at its shareholders rather than making wreckless acquisitions. Only time will tell but from where we stand, this deal is very outrageously expensive for Microsoft.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Microsoft Inc. (MSFT) or any other securities.

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