What is Facebook's magic profit recipe? We may soon find out
Goldman Sachs recently valued Facebook at $50bn. What makes it worth that much is a mystery. But it may soon be revealed.
When I went to see The Social Network, the film about Facebook, I wrote here that I couldn't begin to understand how the company could possibly be worth $25bn. Just goes to show what I know. Goldman Sachs has just put a "super-high and fast-rising" valuation of $50bn on it, says the FT. And this isn't just based on an analyst's "wishful thinking". The firm has also chucked in $375m in cash for a stake. And it is making arrangements for its high-net-worth clients to take and trade stakes in Facebook to the tune of another $1.5bn via a special purpose vehicle.
This is great news for Facebook in that it will allow it to get on with the business of hiring people, developing products and picking up start-ups without the regulatory bother that comes with a listing: no reports, no audits, no revealing of the details of its business to potential competitors. Felix Salmon explains how it might work.
But it still raises the same old question: what makes the social networking site worth quite so much? The simple answer is that, outside Goldman and the firm itself, no one has any idea: "if Facebook has a magic recipe for huge profits the secret is being kept much better than is usual in the tech world" notes the FT. Revenues are expected to have been a mere $2bn in 2010, with most of this coming from bog-standard advertising.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
And while they are apparently increasing at a reasonable pace it isn't easy to see how this will turn into massive profit margins. Google makes big money because a huge number of its searches turn into commercial transactions. But Facebook customers don't so far do much spending. The site is thought to have a much lower click-through ratio than most major websites: its users use it to communicate, not to shop, and are well programmed to block or ignore ads they can't be bothered with. The fact that they are used to using the site for free also suggests they may not be keen to start paying for any new services on it. Google is a utility for its users. Facebook is a hang-out place.
My instinct is to be wholly negative on the $59bn valuation and I'm pretty sure I won't be investing in any IPO. But nonetheless, I'm going to try not to be too sniffy about all this. Why?
Partly because, as John Stepek has just reminded me, a few years back I said that I couldn't for the life of me see how a Google share could be worth $85. (It is now worth $600 - whoops.)
Partly because Facebook overtook Google as the most visited site in the US in 2010, taking an extraordinary 8.9% of the country's traffic (none from Goldman employees by the way their computers block the site).
And partly because Facebook now owns and has access to an astonishing amount of our personal data (let's not forget it has well over half a billion users and rising). I can't yet see a way for them to use that profitably, legally and ethically all at the same time. But if someone else can, and if (this is a big if), Facebook stays popular with its users, $50bn might one day look like small change.
Brett Arends of Marketwatch makes a few heroic assumptions (that everyone on Facebook uses Facebook for example) and does the numbers like this. "Even if Facebook didn't add a single extra subscriber from here, a $50bn market value would work out at $100 per user. To earn a 20% return on $50bn, without any growth in subscriber base or traffic, investors would need Facebook to make $10bn in net income per year. That's just $20 per user per year. It's 7.1 cents for each hour one of them spends on the site."
The SPV being set up by Goldman and Facebook is unlikely to be looked upon particularly kindly by the SEC (it is launching an investigation into private markets such as this) so the general consensus is that Facebook will be forced into an IPO and a lot more transparency by 2012 or so. Perhaps then we will find out if there is a magic recipe and if so exactly what the ingredients are.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
-
Banks given additional 72 hours to investigate suspicious payments
New rules will allow banks to pause suspicious payments for longer, giving them time to investigate cases of potential fraud
By Katie Williams Published
-
What financial support can you get if you are suffering with long-term illness?
Health is wealth and more important than any material riches. But too often, long-term illness brings financial worries of its own. What financial support can you get if you are ill?
By Katie Williams Published
-
House prices to crash? Your house may still be making you money, but not for much longer
Opinion If you’re relying on your property to fund your pension, you may have to think again. But, says Merryn Somerset Webb, if house prices start to fall there may be a silver lining.
By Merryn Somerset Webb Published
-
Prepare your portfolio for recession
Opinion A recession is looking increasingly likely. Add in a bear market and soaring inflation, and things are going to get very complicated for investors, says Merryn Somerset Webb.
By Merryn Somerset Webb Published
-
Investing for income? Here are six investment trusts to buy now
Opinion For many savers and investors, income is getting hard to find. But it's not impossible to find, says Merryn Somerset Webb. Here, she picks six investment trusts that are currently yielding more than 4%.
By Merryn Somerset Webb Published
-
Stories are great – but investors should stick to reality
Opinion Everybody loves a story – and investors are no exception. But it’s easy to get carried away, says Merryn Somerset Webb, and forget the underlying truth of the market.
By Merryn Somerset Webb Published
-
Everything is collapsing at once – here’s what to do about it
Opinion Equity and bond markets are crashing, while inflation destroys the value of cash. Merryn Somerset Webb looks at where investors can turn to protect their wealth.
By Merryn Somerset Webb Published
-
Value is starting to emerge in the markets
Opinion If you are looking for long-term value in the markets, some is beginning to emerge, says Merryn Somerset Webb. Indeed, you may soon be able to buy traditionally expensive growth stocks on the cheap, too.
By Merryn Somerset Webb Published
-
ESG investing could end up being a classic mistake
Opinion ESG investing has been embraced with enormous speed and zeal. But think long and hard before buying in, says Merryn Somerset Webb.
By Merryn Somerset Webb Published
-
UK house prices will fall – but not for a few years
Opinion UK house prices look out of reach for many. But the truth is that British property is surprisingly affordable, says Merryn Somerset Webb. Prices will fall at some point – but not yet.
By Merryn Somerset Webb Published