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".

How will profile searches impact Facebook?

Facebook recently announced:

“Starting today, we are making limited public search listings available to people who are not logged in to Facebook. We're expanding search so that people can see which of their friends are on Facebook more easily. The public search listing contains less information than someone could find right after signing up anyway, so we're not exposing any new information, and you have complete control over your public search listing.”

The decision (as announced) at face value is aimed at letting people search for friends who are on Facebook. It appears to be a logical enhancement of Facebook functionality. But, the ability to search for friends has always been available to registered users. Any user seriously interested in connecting with friends would not mind registering on Facebook at all.

So, why this sudden change of policy permitting (unregistered) users not logged in to search users. What are the other implications of this decision? I have a simple (but, speculative) explanation for this decision.

A recent Online Publishers Association report clearly indicates trends in Internet traffic. The report has shown online traffic to be shifting away from commerce and communications sites to social networking and media sites. Further, users on social networking and media sites spend time viewing other users’ profiles to leverage the possibility of connecting with other users who share interests.

Thus, the opportunity to increase page views might have prompted Facebook into offering the public search listing feature. The objective very well might have been to improve stickiness. Another reason could be to increase conversions. Afterall, a casual visitor is more likely to register if he or she finds another friend or buddy to be a user of Facebook and wants to connect with that person.

So, Facebook seems to have taken a leaf out of the MySpace book. Needless to say this is a step in the right direction. The functionality should have been made available a long time ago.

The decision clearly indicates Facebook is no longer a niche social networking site focusing on the student community, but a mainstream player. It is definitely going to be interesting to watch the “social networking showdown” between MySpace and Facebook over the next few months.

Facebook: A fortified garden

The Internet world in the valley has been abuzz over the last 3 months about the Facebook (FB) announcement to give “an unprecedented amount of access to developers.” The Facebook API would permit third party developers to offer their applications to FB users. Users can browse through and use any of the third-party applications. They can even remove default FB applications and use third party solutions instead.

Besides letting these applications serve their own ads, Facebook has also added a viral element to this ecosystem. When your friend subscribes to a third-party application, it is included in the news stream of that user. So, when notified about your friend’s choice, you can decide to use the application yourself. In other words, your “social graph” (in FB parlance) – your network of friends – will push information to you.

The Implications
This strategy has been hailed for two reasons. One, it makes FB functionally richer and developers get access to the large FB user base. And two, friends can push you information that you might find useful. But, both these advantages have downsides.

To begin with this information push is fine with small groups. But as your network grows, it soon becomes information overload – often unwanted. It ends up becoming the equivalent of unsolicited mail albeit non-disruptive.

It is true that an open Facebook is unlike other social networks, which attempt to lock in users. The obvious goal here is to make available so much functionality on Facebook that users don’t feel the need to look at other platforms at all. This is very similar to the Microsoft strategy of using third-party application providers to gain competitive advantage.

This to them has been Facebook’s valiant attempt to knock walled gardens.