Has Facebook taken Microsoft for a ride?

The Microsoft investment of $240 million to pick up a 1.6% stake in Facebook has attracted significant media attention. The investment obviously puts Facebook valuation at a whopping $15 billion. Let us take a look at some hard, cold facts to analyze the merits of the investment.

1. A Wall Street Journal (Online) report has indicated that Facebook expects to breakeven in 2007 with revenues of $150 million. The Journal also estimates Facebook’s 2007 earnings at $30 million. That equates the Facebook valuation (of $15 billion) at 500 times estimated earnings. Google in comparison is trading at $707 (Oct. 31, 2007) for a market capitalization of $164.66 billion giving it a value multiple of 49.33 (on earnings of $3.3375 billion) – less than 1/10th the valuation multiple of the Microsoft investment in Facebook.
2. If the same “100X multiple” on revenue were used on Wal-Mart Stores, the largest 2007 Fortune 500 company in America would have a market capitalization of $35.1 trillion – almost 3 times the GDP of US.
3. Facebook is believed to have more than 50 million users worldwide. Thus, their value works out to $300 per user. It can be estimated that with its Sept. 2007 global search engine market share of almost 57% (per HitsLink statistics), Google has almost 710 million users worldwide (taking Sept. 2007 Internet World Stats estimate of Internet users into account). At $300 per user, Google should have a market cap of almost $215 billion, which is 30% more than what Google’s current market cap is. And, oh, by the way that would take Google to a share price of almost $1000.
4. Valleywag reports click-through rates on Facebook are astonishingly low at 0.04% (Myspace is 0.10%). This probably is a clear indication of lower disposable incomes of Facebook’s user base. Further, taking comScore Sept. 2007 statistics into account, Facebook generates about 6.0 million ad clicks per month. In comparison, MySpace generates about 45.0 million ad clicks per month. MySpace revenue has been estimated at $525 million for 2007 or roughly at $1 per click per year. The corresponding figure for Facebook is $2 per click per year.
5. According to market research firm Parks Associates, few U.S. consumers are willing to pay a monthly fee to use social networking sites. This online survey of Internet users found 72% of social networking users would stop using a site if required to pay a $2 monthly fee. Likewise, nearly 40% would stop if a site contains too many advertisements. Clearly, Microsoft must have seen value in Facebook’s potential to generate ad revenues and NOT subscription revenues.

Facebook’s monthly burn rate must be in the vicinity of about $15 million. If it has indeed broken even, the Microsoft investment is just insurance money - something that reassures Facebook about its future. Thus, it really does not make a whole lot of sense why Facebook is supposedly thinking of raising additional capital from hedge funds. Do we know all that we need to know about what is going on within Facebook? Why would anyone value Facebook so high?

The Microsoft investment is clearly a bet by Microsoft – a “leap of faith” if you will. Microsoft is banking on the fact that eventually Facebook would be a better destination for online advertisers. Microsoft clearly thinks that unlike Google, Facebook knows a lot about its users, their profiles, hobbies, interests, activities and so on. This helps advertisers run targeted campaigns more effectively. On the contrary, Google does not know any of this information. Thus, Microsoft is hoping that Facebook with help them become a serious player in the growing market of "social advertising".