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:
- 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.
- 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.