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Why Goldman Did Not Quite Value Facebook at $50 Billion – Not Even Close

by Brett on January 13, 2011

The tech world has been up in arms about Facebook’s alleged $50 billion valuation from Goldman Sachs.  But after doing a bit more reading, it looks like that reported valuation is greatly exaggerated.

In yesterday’s edition of Casey’s Daily Dispatch, Alex Daley brought a great sanity check to the $50 billion valuation.  With permission from the kind folks at Casey’s, here’s Alex’s take in its entirety:

The $50 Billion Myth – Facebook and Goldman Sachs

By Alex Daley, Casey’s Extraordinary Technology

The past few weeks have seen a flurry of news in technology with the mega-sized Consumer Electronics show in Las Vegas ushering in the first new platform for Microsoft Windows in over a decade, the announcement of at least 40 forthcoming mobile phones to be the first class labeled with the “4G” moniker, and a rush of new tablets from vendors trying to follow Apple’s iPod into a lucrative new space.

But few announcements have generated more buzz than the widely reported investment by Goldman Sachs in the hot privately held social media goliath Facebook at a staggering $50 billion dollar valuation.

The problem: it’s just not true.

Yes, Goldman will invest $500 million dollars in Facebook in exchange for a 1% slice of the company, according to the little public information available on the private deal. But Goldman expects a quick return on that investment outside the equity value itself, so the valuation implications are far from cut and dry.

In addition to its own stake, the deal also reportedly entitles Goldman to create a $1.5 billion special-purpose vehicle for its investor clients to get their own (minimum $2 million investment, except for Goldman partners) chunk of the closely held startup.

When those clients invest, Goldman takes a 4% placement fee and will also take 5% of any profits generated. This means millions of almost guaranteed dollars in Goldman’s pockets – can you imagine them not being able to raise that money? With a full subscription, they will receive $60 million in fees, with totals rising as high as $125 million if Facebook’s valuation approaches $100 billion on IPO or other private events.

Not only will Goldman see a good chunk of its investment dollars returned to it in the near term through fees paid by its investor clients and solidly contracted business with Facebook itself, Goldman also stands to make far more from the eventual IPO of Facebook. Now a shoo-in for leading the eventual IPO of the firm, Goldman stands to make the standard 6% offering fee.

If Facebook can really attract a $50 billion valuation at market and lets loose just 20% of its equity for a $10 billion offering, that would mean $600 million in fees to Goldman. A lot of factors will determine the value of that commission, but add into it all the fixed fees and commission from debt raises, other private funding events, and general advisory fees, and it is easy to see Goldman rounding out more than $1 billion dollars in revenue from their relationship with Facebook over the next two or three years.

With all of the potential fees now coming their way, Goldman’s own investment says very little about the valuation of Facebook. It’s not a market-based price, and many additional promises may exist to affect the true valuation. Until there is a fair market pricing event, drawing valuation conclusions is a dubious science at best. But that fair market may be just over the horizon, thanks to this private deal.

Facebook has effectively put a clock on its IPO. Any private company in the U.S. with $10 million in assets and more than 500 shareholders must disclose its finances publicly within 120 days of the fiscal year it reaches that threshold. And Facebook is warning new prospective investors that the company is likely to hit that investor limit this year with the new vehicle just created. That means Facebook will probably have to disclose its finances publicly by April 2012.

When technology giant Google reached the same threshold in 2004, it prompted a full IPO of the company shortly thereafter. So, many analysts are now calling for a summer of 2012 offering.

While founder Mark Zuckerberg, who owns about 25% of his company, has long resisted an IPO, the winds appear to be changing. In addition to the 500 investor limit, employees of the company are heavily invested. But employees’ special class of shares does not really become available until an IPO or sale of the company.

The latter is less and less likely as valuations sore. Plus, early private investors are probably itching for more liquidity, especially as demand for the shares appears to be reaching a fever pitch, with multiple private stock sale websites brokering share sales off the markets at extreme valuations these days.

According to insiders who claim to have access to the deal, Facebook posted more than $1.2 billion in revenue in the first 9 months of 2010, with net income of $355 million, or a 30% margin. If revenue holds up in Q4, that will mean a greater than 100% gain over the $777 million in revenue the company is stating it saw in 2009.

As investors in Casey’s Extraordinary Technology have seen, a long-term understanding of cash flow potential can give an investor an edge in the market and produce great gains. In this deal, the insiders are the only ones with access to that information. Goldman Sachs is not about to jump into Facebook without some strong due diligence and a good understanding of its return.

Making valuation judgments with less than full information is always a mistake – this time it is the media that are jumping to erroneous conclusions, not investors. That is, until Goldman opens its new investment vehicle to its pension fund and insurance company clients at the same valuation Goldman took, only without any fees flowing to offset their costs.

Alex Daley is the chief editor of Casey’s Extraordinary Technology

Ed. Note – I am a subscriber and affiliate of Casey’s Extraordinary Technology


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