The following is a full reproduction of part of today’s lex column in the FT (you will need a subscription to read the whole thing online). It is a great article.
In July 2005, Rupert Murdoch snapped up MySpace, for what seemed an aggressive $580m. In September of the same year, eBay’s Meg Whitman had a $3.1bn flutter on internet phone group Skype.
Two years later, how do the two gamblers stack up? Mr Murdoch’s News Corporation is lauded for being early to spot the social networking trend. If rumours of a $10bn valuation for a stake in smaller rival Facebook have any truth, the return on his MySpace investment looks huge. Ebay in contrast, bet big and lost. This week it wrote down Skype’s value by more than $1.4bn. The division has not generated the revenues needed to justify its optimistic price tag and prove the sceptics wrong.
Where does that leave the media and technology giants circling today’s hot, private internet companies such as Facebook? Should they remain disciplined on valuation and risk ‘doing a Viacom’? The media group saw MySpace stolen from under its nose by News Corp in 2005. Or do they pay up, keep an asset out of rivals’ hands, and risk a nasty Ebay-style writedown in the future?
The truth is that a company such as Facebook is no diamond in the rough. At anything like $10bn, the site will have to perform superbly on generating real revenues, as well as just page views, to grow into the valuation,k let alone surpass it. Given fickle user bases and continuing questions over social-networking business models, the risks of disappointment are huge. After all, in spite of MySpace’s success, such a lofty valuation is not factored into News Corp’s share price.
The trouble is there are a lot of deep-pocketed companies, including Google and Microsoft, for which the risk of a multi-billion dollar write-off is not life threatening. The risk of missing the next big thing is huge – witness Microsoft’s desperation, having messed up internet search.
With so much success already baked into valuations, the odds of any bet generating a huge return are thin. But rivals could still scare each other into rolling the dice – espescially if they are only paying for a stake, not the whole company.
This analysis is spot on except in one regard – and that is the regretful/disapproving tone. I agree that a $10bn valuation for Facebook is punchy, but the point the FT is missing is that the pace of change is so fast now that the margin between overpaying today and missing the next big thing is razor thin. This puts big companies in a very difficult place – and some will respond by moving more aggressively to acquire companies earlier and/or at higher valuations.
The same valuation/acquisition logic that applies for Microsoft and Facebook applies for acquirers and internet companies for whom exits in the hundreds of millions of dollars are a big deal – particularly in specific verticals like music and travel. CBS acquired LastFM at lofty multiples for this reason and the same thinking was behind our exit analysis when we invested in WAYN.
This is why I’m bullish on the exit climate for consumer internet companies. (Always assuming the whole economy doesn’t go into meltdown….)