Facebook’s valuation

By September 24, 2010Exits, Facebook

You may well have heard talk recently about Facebook’s $33bn valuation and similarly high valuations for other private companies on SecondMarket.  I’m writing today to share a few thoughts on why we need to be careful with these numbers, but before I go any further, I want to make the point that I think Facebook is a fantastic business with good prospects which has done a great job of innovating beyond their initial product.  Similarly, I think SecondMarket provides a valuable service and it is helpful for small shareholders in private companies to be able to sell their shares before larger shareholders are ready to exit, particularly for companies on the IPO track who are waiting much longer than they used to before listing.

So back to Facebook’s £33bn valuation.  When I first read that number I thought ‘wow, that is high’ but as I said above I’m a believer in this company and I didn’t think it was so high to be worthy of comment.  Reading this post on the 37Signals blog by David Hannheimer Hannson changed that.

David’s argument that Facebook is not worth $33bn has two components:

  1. The $33bn is based on what minority investors have paid for a tiny slice of the company and if they tried to sell the whole thing (or float it) they would get less.  A valuation isn’t really a valuation unless it applies to a whole company.
  2. Standard valuation methodologies would generate a much smaller number – it doesn’t look like they are generating much in the way profits on their $1bn of revenues, so discounted cash flow analysis wouldn’t get you to $33bn, and if you make generous assumptions about the profit they might be making you still get to very high profit multiples (David estimates the highest price to earnings ratio Facebook might have is 165 – which is 7.5x where Google trades).

These arguments are pretty compelling and they apply equally to the other private companies listed on SecondMarket.  It doesn’t hurt anyone to have shares traded at high prices and for these big company valuations to be in circulation provided nobody reads too much into them, which is why I’ve written this post.

For a bit of fun making the same point you can read Press Release: 37Signals Valuation Tops $100bn after Bold VC Investment.

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  • But David is using bad information. He says, “Real money is what’s left over after you pay your expenses.”

    But no one has any idea what Facebook’s true earnings are. Current accounting practices mix current year expenses with investments in intangibles like systems, processes, IP, training branding, user relationship development–in short, the investments necessary to build the knowledge infrastructure that is the core of the Facebook business model.

    These investments will continue to yield results in the future–and equal investments may not be necessary every year. So there may actually be a great earnings story which would justify the valuation.

  • Thanks Mary. You make a good point that a calculation of Facebook’s earnings which netted out future investment of the sort that might be capitalised could yield a figure higher than $200m. That said, I think a lot of their investment is necessary to maintain their current position, so it might not be too much higher – they need to innovate just to stand still.

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  • Chris M.

    I’m no veture capital whiz but, uh, I can do a little math. It must be the simpleton in me bit it’s nice to see things boiled down to the most basic.
    FACEBOOK approx. value, say, $25,000,000,000
    divide by customer count 500,000,000
    Dollar worth per customer = $50
    So the questions is how many of the users are actually worth at minimum $50? Will users pay for the site? If not, can a user earn $50 affiliate dollars for Facebook? How about $100? I would love to see some real traffic data on the 500mil users. An account-aging login history would be nice. How many people haven’t logged in 30 days. as they’re almost worthless to an income model.

    So regardless of the earnings what is the most you could imagine a customer would be worth?

    But I guess if Mark is like the CEO Craig from Craigslist, who cares, it’s never going public. If it does it might be start of a slow death.

  • The value per user is certainly high, although I think the 500m is people who have logged on in the last 30 days – so they are all active, and a good portion of them are are on the site for hours every day.

    And I think Facebook will go public, so at some point all will become clear…