Hi. While this blog is a part of Seed Catalyst’s website, I realised over the initial few weeks that a lot of you are first introduced to the firm via the blog rather than our home page.
So to introduce myself - I’m a business consultant working with early stage technology firms to help streamline their strategy and go-to-market approach and support them for fund raising.
With this blog, I aim to capture key market trends that I see in the industry, the ecosystem and cross-plays in some of the more interesting and upcoming sectors, as well as cover interesting companies that I meet.
I will also be addressing vexing and interesting valuation and deal/term-sheet structures that would be of interest to technology start-ups at various stages of their growth.
The new Facebook valuation has everyone, techie or non-techie, talking about the new media bubble. $50 billion for the social media website with 500 million users, that’s approximately $100 per user. Moreover, this doesn’t include the £1.5billion fund that Goldman is raising from private individuals to invest purely in Facebook. The latest news leads to three questions:
What are their sources of revenue?
The media is by and large comparing Facebook purely to Google in terms of revenue flows i.e. advertising. In this comparison, there may be reason to believe that Facebook cannot have as strong a hold over ad revenues as Google. Why? Google, in a lot of cases, serves as the search engine prior to commercial transactions. There is a higher potential to serve relevant ads. Facebook on the other hand is purely a social platform for a majority of its users.
However in this approach we are ignoring several of the current and future revenue streams which are extremely relevant in Facebook’s environment. This includes Gaming, Facebook credits, Facebook places – all of these may be a small part of the pie currently but they have a significant growth potential. We’ve seen the growth of child portals like Mochi Monsters. Once Facebook gets its privacy concerns addressed, that may be another revenue opportunity (yes, I know, that’s a long time coming but it is an opportunity) Shopping portals, exchange portals, classifieds...the list is endless.
As long as Facebook acts as the platform with a revenue share model and allows developers to let their imaginations go wild with potential uses, all I see is Zuckerberg go ‘KA-CHING!’
Is the valuation really a bubble?
Let’s take a look at the Google IPO way back in 2004. Markets were recovering from the tech bubble and 9/11 when Google started their novel auction based IPO process and the firm settled on a post IPO valuation of $27 billion. The stock had floated at $85 but then finally settled at $100 per share.
In their SEC filing, Google reported revenues of $961.9 million in 2003 (28x) and net profit of $106.5 million (254x). They had been profitable since 2001. As for growth, their revenues had grown at 177% and earnings at 6% since the previous year.
Now let’s take a look at Facebook revenue estimates. They have ranged from $700 million in 2009 to $1.1 billion in June 2010 to $2 billion in Dec 2010. At $2 billion revenues, the valuation is in the Google Price/Revenue range with hardly any illiquidity discount. With an assumption of 15% net margin, we have a P/E of 166x!
Another reference point would be another private firm Zynga. Zynga’s focus is on virtual games and their market is strongly linked to Facebook. Zynga has 237 million MAU users, 67 million active users per day and Second Market transactions estimate their market cap at $2.8 billion. Zynga revenues are estimated at $500 million in 2010. That implies a Price/Revenue ratio of 5.6x (compared to Facebook’s 25x) and a Price/ MAU ratio of 12x (compared to Facebook’s 100x)
In spite of the multiple revenue streams, it does seem like a bubble, doesn’t it?
And yet, if the Facebook valuation had been from Second Market, I would have taken it with a pinch of salt. After all the number would be from investors who have no access to the actual financials of Facebook. But the valuation of $50 billion is from seasoned investors with access to the books.
So why do we still refer to it as a bubble? because the valuation may not be dependent purely on current revenue and future growth potential. DST’s investment could be related to term sheet pay to play terms to maintain their investment level. Goldman wanting to participate in the investment round makes sense to ensure they are the banker of choice when it comes to the IPO and to drum up market interest.
And that brings us to the third question which is linked to the Goldman $1.5 billion Facebook fund or rather the special purpose vehicle.
Is there reason for the SEC to probe the private secondary markets and the Goldman fund – are they a means to evade regulation?
Referring back to the Google IPO again, their bankers were Morgan Stanley and Credit Suisse First Boston. Goldman won’t let that happen again and the current investment and the new fund being raised are clearly insurance measures for the same.
However is it legal? It's hardly surprising any more to have Facebook news which seems under the bar of business fair play be it in their origins, privacy issues, use of subscriber data and now the IPO. Well, we can rest assured that the million dollar lawyers will do their jobs and ensure that the terms are in line with the word of the law. But it is certainly an unhealthy precedent. I had covered the trend is a previous article as Securitization 2.0 (http://www.seedcatalyst.com/joomla/new-developments/innovation-bringing-technology-and-finance-together). At this stage it is a few HNI making the investment. The issue being quoted currently is 'why should only the rich few have the opportunity to invest in firms'. The bigger trouble would start when we have several funds or SPVs being raised for private investments and then traded where no one has an idea of the actual valuation of the investments (sound like CDOs to anyone).
