Merryn's Blog

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.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

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.

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?

Advertisement
Advertisement - Article continues below

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.

Advertisement

Recommended

Visit/517688/the-british-equity-market-is-shrinking
Stock markets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019
Visit/516944/why-wall-street-has-got-it-wrong-again
Economy

Why Wall Street has got the US economy wrong again

The hiring slowdown does not signal recession for the US economy. Growth is just moving down a gear, says Brian Pellegrini.
25 Oct 2019
Visit/511212/reasons-for-investors-to-be-bearish-but-stick-with-the-stockmarket-bulls
Stock markets

There are lots of reasons to be bearish – but you should stick with the bulls

There are plenty of reasons to be gloomy about the stockmarkets. But the trend remains up, says Dominic Frisby. And you don’t want to bet against the …
17 Jul 2019
Visit/510684/good-news-on-jobs-scares-stockmarkets
Economy

Good news on jobs scares US stockmarkets

June brought the best monthly US jobs growth of the year, but stockmarkets were not best pleased.
11 Jul 2019

Most Popular

Visit/economy/uk-economy/600837/rishi-sunak-new-chancellor-spending-splurge
UK Economy

Britain has a new chancellor – get ready for a major spending splurge

The departure of Sajid Javid as chancellor and the appointment of Rishi Sunak marks a change in the style of our politics. John Stepek explains what's…
14 Feb 2020
Visit/economy/600814/money-minute-friday-14-february-the-latest-from-rbs-britains-state-owned-bank
Economy

Money Minute Friday 14 February: The latest from RBS, Britain's state-owned bank

Today's Money Minute previews results from RBS – Britain’s state-owned bank – and from pharma giant AstraZeneca.
14 Feb 2020
Visit/economy/600813/money-minute-thursday-13-february-latest-numbers-from-barclays-and-centrica
Economy

Money Minute Thursday 13 February: latest numbers from Barclays and Centrica

Today's Money Minute previews earnings reports from Barclays Bank and Centrica, plus the latest US employment picture
13 Feb 2020
Visit/517625/tr-european-growth-trust-why-investors-shouldnt-overlook-europe
Sponsored

Why investors shouldn’t overlook Europe

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, tackles investor questions around Europe’s economic outlook and the conseq…
6 Nov 2019