As the holiday season comes to a close it is being reported that Goldman Sachs has invested $450 million in Facebook at an alleged market valuation of $50 billion. How does even the mighty Facebook justify such a number? The answer is elusive.
There is no conventional market in Facebook shares though it is understood to be the most popular stock on the so-called SecondMarket. This 'off'-the-books' operation is a quasi market when compared to conventional stock markets because it operates behind a veil of secrecy where public information is at best speculative. Any talk about values has to be based not upon public information but the perceptions of those investing.
Over the last year, it is said that Facebook's value has risen sharply as the number of users has grown. This has coincided with speculation about raises in Facebooks's income. However, there are other possible explanations.
As part of the most recent reporting, it is said that Goldman Sachs is planning the creation of a 'special purpose vehicle' that will allow it to pool investor funds into a consolidated fund that owns shares in the companies in which it invests. In this case, it is said that Goldman will create a fund specifically for investing up to $1.5 billion in Facebook.
While there is nothing inherently illegal in this arrangement it makes a laughing stock of the notion of public accountability for the benefit of investors. The SEC is looking into this type of arrangement. When a company has more than 499 investors then it must disclose its financial condition.
Using a SPV might allow Goldman to attract many investors (from which it will draw management fees) but avoid the problem of tipping Facebook over the 499 investor line. However, this is not a done deal. If the SEC decides that it can peer through the SPV then Goldman's plans will be scuppered. Setting a valuation at $50 billion AND holding out the promise for massive additional investment is a win for Goldman but what about everyone else? What does Goldman know that others do not?
Since the valuations are based on what amounts to the sentiment of a private club then there are only one of a very few possibilities. Let's a try a few known or near known facts and then speculate about the remainder.
Assuming that every one of those employees is paid $150,000 pa then its total payroll for the year can be guesstimated at around $200 million allowing for growth over the year. Why does this matter? Payroll is one the main costs of running a software business. Let's also assume Facebook is running at average-ish cost of service provision. That could be 8% of revenue. Pick your total cost based upon whichever revenue number you like. Now factor in amounts to fork over for data center operations and amounts paid back to affiliates and the big game builders and what number do you come up with?
Google has been profitable for a long time and regularly records 35% operating margin. 37Signals thinks the earlier $33 billion Facebook valuation was 'bizarre,' believing that Facebook could not be making more than 20%. But is that true?
No-one knows for sure but even a highly conservative crunching of the numbers suggests that Facebook has recently become insanely cash positive and profitable. If that's correct then a $50 billion valuation may not be as outlandish as it sounds. But...but...but...
I have a sneaking feeling that part of this current valuation is tied to Goldman wanting to make a market as a sell side banker. Add in the fact that SPV's have a dark history going back to the days of Enron and suddenly the valuation takes on a different feel.
The only way we will find out is if the SEC digs into Facebook and takes a dim view of Goldman's SPV. Given the SEC's less than robust history of investor protection, I am not holding my breath.