Deal Radar 2008: Facebook Woes Coming?

Facebook is the most popular social networking site providing an interactive space that helps members communicate with “friends”. The site features like ‘Wall’ and ‘Poke’ have created a vernacular amongst the youth population. It was started in February 2004, by Harvard student Mark Zuckerberg. “Are we Facebook friends?” has now become a social phenomenon!

Angel Financing of $500,000 came in September 2004 from Peter Thiel of PayPal fame. Series A financing of $12.7 million in May ’05 came from Accel Partners. A $25 million Series B in April ‘06 came from Greylock Partners and Meritech Capital along with previous investors. The series C financing of $300 million came in October ’07 comprising of $240 million from Microsoft for a stake of 1.6%, and the balance from Li Ka-shing, Marc Samwer, Oliver Samwer and Alexander Samwer. The Series C valuation was pegged at $15 Billion.

According CEO Mark Zuckerberg revenues for the year 2007 was $150 million and he projects a revenue of $300-$350 million for the year 2008. With an estimated Capex of $200 million (to go into servers) and a projected EBITDA of $50 million, the company’s estimated cash flow will stand at a negative $150 million.

As per Quantcast the website is ranked 16th and unique visitors in U.S. alone for December 2007 was over 35 million.

Rumors are floating that Facebook may strike a mobile deal with Nokia which would give them a greater space in the mobile web. Nokia may also take an equity stake in Facebook. There is another rumor that Facebook is set to acquire Plaxo for $100 million to $200 million.

So what is Facebook’s destiny?

Microsoft’s investment in the month of October 2007 was based on an estimated valuation of $15 billion. If we apply a 15X revenue multiple (higher than that of Google’s 11, and let’s assume for a moment due to its extraordinarily high monetizing potential), to the estimated revenue of $350 million, its optimistic valuation turns out to be $5.25 billion. Based on that we get an EBITDA multiple of 105, which is much higher than Google’s 29. Moreover, we may see valuation receiving a cold shower, given that even Google just missed its earnings because it is finding it difficult to monetize its social networking sites.

By any measure, $15 billion appears to be an exorbitantly high valuation.

No investment banker in their right mind would be willing to take Facebook public at this valuation. They could go for an auction-based IPO that Google popularized. But investors have to be really stupid to pay this astronomical value for a company that is still in its adolescence with an unproven road map for sustainable revenue and profitability (at that scale).

Would anyone buy the company? Most certainly not at that valuation.

Looks to me like Facebook has been frozen. By whom?

By two entities, to be precise. By Microsoft’s brilliant business acumen, and by Zuckerberg’s adolescent ego. Let’s look at each separately.

Microsoft has been looking at its own failure to compete with Google in Search specifically, and in Consumer Internet in general. Meanwhile, Facebook has materialized from thin air with the promise of changing the entry-point to the web from Search to Social Media. Facebook is the only company that makes the Google guys uneasy. They don’t quite understand what the ramifications of this phenomenon could be.

Microsoft thought to itself, “Google must not acquire Facebook. Neither should Yahoo. Let’s play to this kid’s ego, and by sprinkling $250 Million on the exercise, we can establish an artificially high valuation that would bring their options of exit down to zero.”

And they did.

On the receiving end, 23-year old Mark Zuckerberg was thinking, “I must be a real stud, I’ve now got Microsoft eating out of my hands!” If some adult at the investor table tried to mumble that this valuation may cause some problems, he was appropriately silenced by the euphoria of
the $15 Billion.

Now, Facebook is running up expenses, hiring like Google, riding high and mighty. Let’s see how long this lasts. As I said before, Facebook needs to back-fill the valuation to get out of this fix. If they can do so, the Facebook story would have a happy ending.

Otherwise, this will be a tragedy of Shakespearean proportion.

This segment is a part in the series : Deal Radar 2008