By BoLOBOOLNE payday loans

Microsoft buys tiny stake in Facebook: Game on!

After months of rumors about companies trying to buy Facebook, yesterday a deal was announced.  In a sense the deal is quite small because Facebook sold just a 1.6% equity stake to Microsoft.  But by paying $240 million, the deal values Facebook at about $15 billion!  What’s going on here?  This surely can’t be based on rational economics, can it?  Let’s analyze how these deals should be valued and take a few steps back through recent internet acquisition history for context. In trying to keep this post focused, I wrote a separate article about why mergers and acquisitions rarely work.

Economically, companies should be valued at the present value of their free cash flows.  That is to say, project forward all the possible ways the company might behave, and take a probability-weighted average (expectation value) of the total dividends the company would pay in each of these scenarios.  Discount these cash flows by an appropriate discount rate and you’ll get a fair market value for the company.  This is called fundamental analysis.

Now anybody who’s tried their hand at such financial calculations will know there’s a lot of judgement calls involved.  Small differences in numbers like discount rate or growth rates have huge effects on the results, and these numbers are hard to judge.  So it’s definitely possible to come up with a believable (by some) model of future cash flows that will value any currently successful company at whatever huge valuation you want.  But that doesn’t make it correct.  Is Facebook worth $300 per user?  It’s not possible for me to click on a $10 CPM ad every day for 100 years, but maybe they can add more users to grow into that?  Maybe?  It sure seems high.  I think there’s something else going on.

For context, think back to March of 2005 when Yahoo bought Flickr.  IMHO that made Google feel bad because Picassa wasn’t doing so well.  I think they saw this as a big missed opportunity to help organize the world’s photos.  I think this was big on their minds when they paid too much for YouTube.  And Google is still very far from monetizing this investment.  But they now control the dominant way that videos are communicated on the net.  This has to help them feel good about getting closer to their corporate mission of organizing the world’s information.  Since it’s not clear right now how they’re going to achieve that goal for photos.

Now consider Facebook.  Left and right, Facebook’s internal applications are surpassing total usage of th best dedicated net applications.  Their invitation app gets many times more usage than evite, and I believe their photos app is actually well beyond flickr in terms of usage too.  I don’t know where they stand for videos right now.  But it’s clear that they are a force to be reckoned with.  As I’ve written before, their application platform is potentially game-changing because it’s very attractive for information service developers and democratizes the process of product development in a novel and powerful way

For all these reasons, I think Facebook has the potential to dislodge Google as king of the hill.  No, Facebook isn’t going to become the dominant search engine, or even the dominant deliverer of internet advertising.  But I think Facebook could become the dominant way the humans communicate with each other using computers.  This could be the leverage they need to claim the crown of innovative thought leader on the internet.  If I were running Google, I’d be concerned about this possibility.  If I were running Microsoft, I’d be excited to get a piece of this.  Any piece.  Because even a tiny piece (like <2%) means that Google can’t take control of Facebook.  And yesterday, Microsoft got their foot in that door.  So, the game is on.  It’s gonna be fun.

  1. leodirac says:

    @Greg – you’re right to highlight the inconsistency. Certainly one way Facebook could unseat Google could be to deliver more ads. Although, as my recent thinking on social media points out, the same effect could be achieved through a different channel that we might not call “ad delivery.”

    Also, despite Facebook’s lack of obvious monetary success so far, I believe they are well on their way to achieving this vision. They control by far the most detailed database of psychographic data that can be used to target ads in a way that Google can’t. The world is becoming increasingly dependent on Facebook as a communications medium. So long as these trends continue, it will be easy for them to monetize these assets in the future.

  2. Greg Linden says:

    It is hard for me to see how “Facebook has the potential to dislodge Google as king of the hill” if it “isn’t going to become … the dominant deliverer of internet advertising.” Google is an advertising company. That is how they make their money. I would think that dislodging Google as king of the hill means dislodging them as the dominant deliverer of internet advertising, no?

    And, as impressive as Facebook’s usage is, they have had little luck in monetizing their traffic so far. It turns out to be extremely difficult to target ads to Facebook profiles and status updates, mostly due to lack of immediate purchase intent when people use Facebook. It is hard to get people to buy something when they are on a mission to do something else.

  3. Anonymous says:

    I bring this up as a reason for Google to feel threatened. Unknown startups can always sneak in and take over, but the unknown startup doesn't pose anything like the clear and present danger of an established company on an exponential growth path.

  4. Jose says:

    "But I think Facebook could become the dominant way the humans communicate with each other using computers."

    I'd broaden to say "Facebook or something like it" could become dominant. I agree with your assesment of it's potential but you can't preclude the prospect of a better offering emerging from left field just a year or two from now. And as good as Facebook is (I use it avidly myself) it's not hard to imagine somebody doing it better.

  5. Jose says:

    "But I think Facebook could become the dominant way the humans communicate with each other using computers."

    I'd broaden to say "Facebook or something like it" could become dominant. I agree with your assesment of it's potential but you can't preclude the prospect of a better offering emerging from left field just a year or two from now. And as good as Facebook is (I use it avidly myself) it's not hard to imagine somebody doing it better.

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