Microsoft and Facebook to Strengthen Strategic Alliance
As a progressively conservative businessman, I take an objective approach in my analysis of pending transactions, looking for value and risk that others may not see. One of the stories to hit the newspapers and blogs last week was the $10 billion to $15 billion valuation that Facebook is seeking from Microsoft. In an article at AllThingsD, Kara Swisher discusses her conservative view on the expenditures coming out of Silicon Valley and how they relate to Facebook.
Today, The Wall Street Journal follows up on my story by adding more interesting details, including the fact that Microsoft is seriously considering an investment offer that would value the company at $10 billion.
(Google might be in there too, according to the story, but I think it is just there to annoy Microsoft.)
In any case, this was the ludicrous price once floated by Founders Fund’s Peter Thiel, Facebook’s first investor, which was widely derided at the time he uttered it.
More laughable still is that Facebook, according to the Journal story, might be holding out for a $15 billion valuation.
Why? Because I believe Silicon Valley can now be considered to be at Delusional Level Red. Or green, given all the cash that is being shoved in Facebook’s direction now.
(Full article here)
In the shadow of the sub prime real estate crisis, I understand the fear about overvaluation and how it further stretches this bubble. The difference between this deal and to a certain extent the outright purchase of 3COM, is the amount of debt that is assumed by the investors. From what I understand about Microsoft’s investment, they are injecting their own cash which bypasses the leverage risk associated with most private equity investments.
A typical PE deal involves buying a company for 4-5x cash flow or EBITDA (earnings before interest, taxes, depreciation, and amortization) and injecting 20-30% of its own equity. The remaining equity would be borrowed from the banks and the debt would become part of the acquired company. This allowed investors to make small improvements to the acquired companies to improve performance and recuperate their investment.
However, over the past few years low interest rates made borrowing funds cheaper for the PE investors, and they began to overpay for companies. Prior to the subprime crisis, investors were paying upwards of 15x EBITDA for companies and did not have a viable plan to create value out of their investments. These overpayments increased the debt needed to complete the transaction, and while rates were low, interest payments were too high for companies to sustain themselves.
(http://www.techcrunch.com/2007/09/28/private-equity-eats-avaya-for-82-billion-and-3com-for-22b-burp/trackback/)
David Kirkpatrick, a Senior Editor at Fortune weighs in on the transaction, discussing the disruptive advertising effect that Facebook will have on Google and the Internet as a whole.
This matters in business terms because the Internet is rapidly moving toward a world in which advertisers are able to target their messages to those most likely to be responsive.
While this is often painted as an invasion of privacy, in fact it is a service. If these future systems work the way the ad industry expects them to, the ads we see will quite often be ads that convey information we want. If software algorithms can help marketers identify what sorts of goods and services we are most likely to buy, it is a benefit, not an intrusion.
Facebook may be the best place yet for marketers to experiment with these new techniques. Unlike its bigger rival MySpace, Facebook’s individual profile information is intended to represent a real person precisely and accurately. So by investing in Facebook, Microsoft - or Google or another intrepid company -may be buying access to a tremendously valuable testbed for the future of web advertising.
(Full article here)
Google’s approach to advertise the global internet landscape has caused them to lose focus on how to stay within their niche. Instead of focusing on being a top-tier search engine, they are trying to take Microsoft and Facebook head on by offering competing productivity software and social networks respectively — which are already saturated with competition. The problem is that they are following an acquisitive growth model and aren’t allowing their portfolio to take root with the company. This has in my humble opinion created an overvaluation of the company in the global capital market.
In comparison, Microsoft is valued at 1/20th of the price, pays a 1.50% dividend, has no debt, and a boatload of cash. They have tangible products in their software and consumer electronics divisions and have been planning their investments carefully. While I agree that Facebook’s valuation may be high, Microsoft is spending $500MM to buy a 5% equity stake in a web platform with 40MM+ users.
What I don’t understand is why the technology community keeps focusing on Facebook as just another “social networking website” that provides cute gimmicks to bubbly students. In my humble opinion, members of this community do not see the true value of Facebook’s growth because they joined the site three years after its start when the doors were opened to the public.
I first joined Facebook in September 2004 when it became available to my University. I was told about the site — which at the time was located at http://thefacebook.com, by my friend Sara who had used the site at WashU. Facebook’s strategy was to follow an organic growth model, building its user base by slowly expanding across college campuses. This created two effects: College students had an easy way to connect with each other and maintain relationships post graduation, and an opportunity to reconnect with people from their past.
Facebook was created to focus first on people we knew, not people we thought looked cute a-la Myspace. This is why the growth that Facebook sees now is sustainable until they mature, and why Myspace is increasingly losing its market share. A prime example of someone using Facebook against its intended use is Robert Scoble, who is proud that he hit Facebook’s limitation in connections. This attitude, which I find to be prominent in the technology sector, is that the internet is a popularity contest and they dilute the value of their friends / followers / connections / etc. Most sites on the Web maintain this attitude because it is their belief that the more eyeballs they have, the more money they can make through AdSense revenue. Eventually, we are going to reach a point where Google becomes too saturated with advertising partners that it will no longer be a strong source of revenue generation — a model that many new technology startups use.
Furthermore, the community is focused on Microsoft’s past ills and they forget the sheer amount of philanthropy generated by the Bill & Melinda Gates Foundation. Microsoft’s investment in Facebook gives Bill Gates an opportunity to act as an advisor to a young visionary, helping him avoid the mistakes that he made in the past with Microsoft. Together, Facebook and Microsoft can build an online business and entertainment platform that will revolutionize how the online landscape is monetized.
Posted on September 30th, 2007 | By: David Litsky | Filed under Web Technologies
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