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Friday, Jan. 21, 2011
Facebook and dark matter
Special to The Japan Times
HONG KONG — News that Goldman Sachs has taken a $450 million stake in Facebook in a deal that puts a $50 billion valuation on the fledgling company raises interesting and somewhat troubling questions beyond the immediate gawping and jaw-dropping headlines that a spotty-faced Harvard dropout aged 26 is not only Time's "Person of the Year," but is also worth $12 billion plus (based on Mark Zuckerberg's 24 percent stake in Facebook).
Is Facebook really worth $50 billion, near the market value of Boeing, or more than the value of Goldman's rival Morgan Stanley? It is difficult to know when Facebook has not made any accounts public. According to the stock-sale memorandum prepared by Goldman, Facebook's 2009 revenues were $775 million and profits were $200 million. In 2010, revenues rose to $2 billion, and profits to $500 million, so the valuation is 25-times revenue (against Google's valuation of seven-times revenue).
The very fact that Goldman Sachs and Facebook had "friended" each other prompted other rich people to consider buying Facebook shares. San Francisco newspapers reported earlier this month that the private shares market Sharespost sold 165,000 shares for $25 each in a "significantly oversubscribed auction," valuing the company at $56 billion. A well-known analyst was quoted as saying that by 2015 Facebook could easily be worth $200 billion.
"Friending" hot companies generates good business. Goldman has put itself in the front seat to manage Facebook's initial public offering — expected in 2012 — that would net $140 million if $2 billion of stock were sold.
The bank has already secured arrangements to sell $1.5 billion in Facebook to private clients, each of whom will have to commit more than $2 million, for which they will pay 4 percent plus 5 percent of any profits. (Goldman had expected the offering to be heavily oversubscribed, but announced Monday that the offer would be available only to investors outside the United States because of concerns that the level of media publicity about it this month could violate U.S. securities regulations.) No doubt Zuckerberg will be grateful to have Goldman manage at least a clunky chunk of his personal fortune thus unlocked.
Simon Johnson, economics professor and former chief economist at the International Monetary Fund, in his typical feisty style, asked why the U.S. taxpayer should subsidize Facebook and asked whether Goldman was helping to blow the next bubble. He was referring to the fact that, as a bank holding company, Goldman Sachs has unfettered access to the Federal Reserve's discount window — and thus low cost of capital.
"Any financial institution with such access to such government support is likely to take on excessive risk — this is the heart of what is commonly referred to as the problem of 'moral hazard,' " Johnson said.
The key question is what is Facebook really worth. Google — with a rough value of about $200 billion today — has frequently been cited as the marker. The Lex column in the Financial Times commented that Facebook seemed to be increasing its revenues at a faster pace than Google did in its early days. But: "It has not yet replicated Google's greatest success: finding a way to transmogrify a pleasing user experience into high profit margins."
On Google, a high proportion of searches were, in Lex's words, "actually pre-commercial interactions. On Facebook, it seems as if fewer users are in a spending mood. Unless (Facebook) provides more than a modern version of mass entertainment, it will struggle to justify the most recent valuation."
Henry Blodget, editor of The Business Insider, in a careful analysis noted that Facebook is trading at 100-times last year's earnings. He calculated that if present trends continue, Facebook's earnings could rise to $1 billion this year, $2 billion next and even $3.5 billion by 2013, which could justify the $50 billion valuation on the pattern that rapidly growing companies trade at 20-times earnings. But who knows? Today, "There is nothing special about Facebook's stock except that right now Facebook is the 'IT' company that is taking over the world and its stock is going nowhere but up and everyone wants a piece of it."
There are wider objections to Facebook. In a thought-provoking article in Scientific American in November, Tim Berners-Lee, the founder of the World Wide Web, criticized Facebook, along with other social network sites, for infringing the universality of the Web. Berners-Lee argued that "The Web is critical not merely to the digital revolution but to our continued prosperity — and even our liberty. Like democracy itself, it needs defending."
The problem according to Berners-Lee: "Facebook, LinkedIn, Friendster and others typically provide value by capturing information as you enter it: your birthday, your e-mail address, your likes, and links indicating who is friends with whom and who is in which photograph. The sites assemble these bits of data into brilliant databases and reuse the information to provide value-added service — but only within their sites. Once you enter your data into one of these services, you cannot easily use them on another site. Each site is a silo, walled off from the others. Yes, your site's pages are on the Web, but your data are not. You can access a Web page about a list of people you have created in one site, but you cannot send that list, or items from it, to another site."
Some supporters do believe that Facebook is going to take over the world — and several governments envy its immense collection of data on individuals. It has 550 million active subscribers today, though only 92,450 in China where government blocking and the popularity of Tencent make it an outsider. Its supporters note that the company is collecting "taxes" of 30 percent plus marketing expenses on successful group-buying and social gaming businesses being built on top of Facebook.
This opens a very real question of what kind of world is being built, and offers reminders of the new worlds of H.G. Wells, Aldous Huxley and George Orwell, where human beings were stripped of their freedom by dedication to consumption or controlling governments.
Kevin Ferry, cofounder of Cronus Futures Management, said: "American degradation of the sublime into the irrelevant takes place only slightly slower than the speed of light. The Internet is a little slice of serendipity cast off when great men dared to think about heavier things. Facebook is the Dark Matter of the Universe."
Kevin Rafferty is editor in chief of PlainWords Media.