Global Strategy - blog

In November last year, I criticized the logic with which some people calculated the valuation of Facebook corporation to be 15 billion dollars (see an original article as well as a further comment and a related article). I suggested that perhaps the fundamental value of this corporation could more realistically lie between 3-5 billion. Now, an interesting new piece of analysis arrived today: Valleywag news site calculated Facebook's current value to be 2-3 billion.

My original criticism was targeted at the following logic: some analysts and journalists interpreted Facebook's value to be 15 billion because of the fact that Microsoft Corporation had paid 240 million for a 1.6 % stake in Facebook (240 million / 0.016 = 15 billion). Yet, in the deal in question, Microsoft paid the 240 million dollars primarily for a strategic contract/alliance whereby this IT giant obtained exclusive rights to broker ads for Facebook's international sites and to offer its digital platform.

Exclusive selling rights are, by default, quite valuable -- as we know from monopole theories -- and for the kind of rights that Microsoft obtained (to act as an exclusive broker of the ads for the highly popular social media site), paying 240 million might very well be worthwhile.

Now, inferring that Facebook's value -- in financial sense -- was indeed 15 billion would have required that Microsoft had paid 240 billion just for a 1.6 % stake of Facebook's future net cash flows rather than for any strategic contract or alliance. This would basically mean that the aforementioned exclusive rights wouldn't actually have been included in the deal at all (or been worth anything).

Nevertheless, since those exclusive rights were -- unquestionably -- a major part of the deal, the 15B inferral inevitably goes in the wrong. Even pretty badly.

Namely: perhaps the exclusive ad-brokerage rights that Microsoft bought were in fact valued at up to 200 million dollars... This would leave the 1,6 % financial stake of Facebook's future cash flows to have the value of 40-50 million only (240million - 200 million). With these figures, a new calculation of the market value of the whole Facebook corporation, as an independent firm, would thus give us a range of 2.5 billion-3.1 billion dollars (40 million / 0.016 or 50 million / 0.016). Needless to say, this is quite a different figure from 15 billion -- a sum that Microsoft most likely would not have paid for the whole for Facebook.

***

Going back to where I started, Valleywag news site calculated today Facebook's current value to be between 2-3 billion -- a range quite close to the result of my hypothetical calculation a year earlier (above).

Valleywag's estimation is based on the fact that there have been informal, private markets for Facebook's stock, where Facebook's employees have sold some of their shares. Based on the prices for which the shares have been trading ($2.5--5.5), Valleywag calculates the current valuation of the company be at most 2.3 billion dollars.

Now, some might wonder: "how come the value of the company vanished in less than a year, from 15 billion to 2.3 billion" (see e.g. Taloussanomat article). However, I hope I have made it clear that the value might not have been 15 billion even in the first place.

***

I must make a final remark though. Namely, I think that even Valleywag's logic is not very sound. One should not infer the fundamental value of a firm on the basis of a few stock trades made by a few individual stockowners in an informal market. After all, the individuals who have sold their stocks may have been obliged to do so for a low price because of an unfavorable personal situation or some other reason.

Thus, I would be inclined to valuate Facebook a bit higher now than Valleywag. Perhaps 5-10 billion...? Anyone?

(Why, then, would I valuate the company higher than what I did a year ago? Well, I think that during the past year, Facebook has provided me a bit more confidence that it is not just a one-year fad. It has maintained its popularity and the traffic at its site. No serious competitors have emerged either, or are in sight... At least not yet)