Is Facebook really worth $50 billion?

And will its new financing scheme fall foul of regulators?

IN 2009 Rolling Stone described Goldman Sachs, an investment bank, as “a great vampire squid” that likes to stick its “blood funnel” into anything that can make it money. This week the squid inked yet another high-profile deal. Together with Digital Sky Technologies (DST), a Russian group, Goldman invested a total of $500m in Facebook, valuing the world’s most popular social network at a whopping $50 billion. The bank is also planning to set up a fund it will manage that will pump up to $1.5 billion more from wealthy investors into the company.
For Facebook, the deal provides a mountain of extra cash to invest in things such as new data centres and acquisitions. It gives it fuel for further growth without the hassle of listing its shares. For Goldman, the transaction represents an opportunity to stick its “funnel” into an internet firm that makes investors drool. As well as benefiting from any further appreciation in Facebook’s value, the bank plans to suck up fees for managing the new fund. And it is no doubt hoping that by cosying up to Facebook’s top brass it is boosting its chances of leading an eventual initial public offering (IPO) of the company’s stock.

News of the deal has sparked vigorous debate. Facebook’s implicit value has risen fivefold since mid-2009, but sceptics doubt that a firm whose business model is unproven is worth more than established media giants such as Time Warner (see chart).
Since Facebook is not obliged to divulge financial information, it is hard to know for certain whether Goldman and DST, which already owned a sizeable chunk of Facebook stock, are overpaying. But Facebook bulls argue that the network’s sheer scale is proving irresistible to advertisers. Debra Aho Williamson of eMarketer, a research firm, notes that Facebook has even begun to attract notoriously conservative—and deep-pocketed—advertisers such as Procter & Gamble.
The company is also starting to look more and more like a natural monopoly. MySpace, which used to dominate the social-networking arena, has come to look like My Empty Space. It is rumoured to be about to make yet more cuts to its workforce. And networking upstarts such as Twitter, which has also seen its valuation soar (to $3.7 billion), have revenues that are a mere fraction of Facebook’s, which are said to have hit $2 billion last year.
Still, at $50 billion Facebook looks rather expensive. If its sales really are $2 billion a year, that implies that Goldman and DST are paying 25 times current revenues for their shares. That would be a breathtakingly steep multiple, even by the giddy standards of the start-up world.
Squid’s in
Moreover, Facebook has nowhere near as robust an advertising model as, say, Google, whose search-related ads are served up to users when they are often on the point of making a purchase. Much of Facebook’s revenue comes from low-end display advertising. And though it will benefit from marketers’ growing interest in word-of-mouth promotion, the company will have to scrap for those dollars with traditional media brands, whose rich content makes them attractive venues for social-media advertising too.
In spite of this, investors are still falling over one another to get their hands on Facebook’s shares—and Goldman is keen to help them, so long as they agree to abide by certain rules. Clients considering signing up to its proposed Facebook fund are reportedly being asked to commit at least $2m each to it and to hold on to any shares they receive until at least 2013.
A different problem for Facebook and Goldman is that Goldman’s planned fund could fall foul of the Securities and Exchange Commission (SEC). On January 3rd SecondMarket, a broker-dealer in private-company shares, said it had been asked by the SEC for data about pooled investment funds formed to buy private-company stock—precisely the kind of vehicle that Goldman has in mind for would-be Facebook investors.
In recent months several other financial institutions have formed similar special-purpose vehicles that invest in private companies’ stock, piquing the SEC’s interest. This has prompted predictions that regulators may end up treating such entities not as a single shareholder, but as a collection of individual investors. That would have important implications for the companies in which they invest. An SEC rule requires private firms with 500 or more shareholders of record in a given type of stock to publish quarterly accounts and audited financial statements. Faced with such obligations, most firms seek a public listing. This rule was one of the reasons that Google ultimately decided to go public in 2004.
Having to go public now would be a nightmare for Facebook and Mark Zuckerberg, its founder and chief executive, who is said to be keen to put off an IPO for as long as possible. The firm reportedly had fewer than 500 shareholders at the end of last year, including employees and venture capitalists, so it is no doubt hoping to avoid having its arm twisted.
Facebook and Goldman seem to have the letter of the law on their side. Joseph Grundfest, a professor at Stanford Law School and a former SEC commissioner, points out that the rule in question states very clearly that a fund such as the one Goldman has in mind should be treated as a single shareholder. “If someone says Goldman is violating the law, then they obviously don’t know the law,” he says. Were regulators to interpret the rule in any other way, it would have far-reaching consequences for, say, the venture-capital industry, in which funds with multiple investors routinely take stakes in private firms.
However, some observers say that the SEC may be tempted to conclude that the new breed of special-purpose vehicles being created by the likes of Goldman have been set up specifically to get around the 500-shareholder rule. They have the potential to include a much wider range of investors than a typical venture fund, and may attract heightened scrutiny.
Regulators have a duty to protect investors and weigh the concerns of companies that wish to remain private. It is a delicate balancing act. But anyone who invests in a market this frothy must surely realise it is also risky. Meanwhile, Goldman and the other banks which hope to turn these vehicles into a big business should consider friending some good lawyers.