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Understanding Facebook's Valuation
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Understanding Facebook's Valuation
With the rising hype of Web 2.0 and it’s exponents like Facebook, Youtube et alia, the rumored valuation of those companies has also risen sharply. It is currently rumored that Facebook has reached a valuation of 10 - 15 bio USD with only 150 mio $ yearly revenues - not profit.

Facebook has only 300 employee’s and is not making a lot of revenue. If you compare to the also very hyped Google, making about 17 bio $ revenues a year and worth 200 bio USD, you find that with 100 times it’s revenue it’s worth just 15-20 times as much as Facebook. How can this huge valuation of 15 bio USD of Facebook be explained?

It is obvious that Facebook has gained a huge amount of traction, reaching almost everyone who is on the web. In a recent evaluation it was found that 22% of Canada’s population is currently on Facebook. These are more people for example than any Canadian political party has members.

A part of the valuation is certainly justified by the huge leverage you can create by having a fifth of a population in the same network. Think about polls, advertising, recruiting, government communication etc. You can now reach more people through facebook than through a newspaper or Television. Imagine Government sending out official documents to everyone that is in its country’s network.

All those opportunities create great revenue sources - and if combined with a potential of 200 to 300 mio users worldwide - can make one understand how much value could lie in this company.

A comparison with other US internet companies shows that facebook is already the 5th largest considering market cap, only surpassed by Google, Yahoo, Amazon and Ebay, all of them making 100 of millions if not billions in profit every year. Facebook’s 2007 net income is said to be around 30 mio USD, amounting to a P/E Ratio of 500 (Google’s P/E ratio is 50).

Facebook has been able to reach this valuation because of two main factors:

1. The idea that there is the need for only one social operating system and that facebook is the one

2. The bidding war between Google and Microsoft

The first factor, if true, allows to draw many conclusions on the potential of facebook. If it is going to be the Microsoft of the internet, the start page of every user and where every other company is going to build their application on top of facebook instead of creating their on website then yes, a valuation of this size does make sense.

Now I would suggest that the second factor has an almost greater importance. Google has made the right move against Microsoft many times: Search Engine, Gmail, Google Docs. Myspace ad deal, Youtube and others. The people in Redmond wanted to make sure that times they were the ones getting the right deal. And even if it would turn out to have been the wrong decision, 240 mio USD is likely to hurt Microsoft when they’re also getting the advertising deal with facebook that should generate substantial revenue over the next few years. It is also smart in terms of recruiter marketing, proving that Microsoft is serious about Web 2.0.

Certainly Microsoft has been willing to pay more for a stake in facebook than a traditional investor - that was not getting any extra deal with his investment - would have been. There have been rumors that two hedge funds have invested in facebook at the same valuation, though.

It will be interesting to see what happens when facebook goes public. Will the public enter the hype and drive the stock price into valuations even more exorbitant than the current?

by Flavio Rump, October 29th, 2007. Flavio Rump is currently an entrepreneur at bluepixel and a student of mechanical engineering at the Swiss Federal Institute of Technology in Zurich (ETHZ). In his personal blog (http://www.flaviorump.ch) he writes about social networks, politics and business issues mostly focussing on Switzerland. Flavio has also been a candidate in the election for the national council of Switzerland.



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