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Facebook Registers The WHOLE WORLD! Or At Least They Would Have To In Order To Justify Goldman’s Pricing: Here’s What $2 Billion Or So Worth Of Goldman HNW Clients Probably Wish They Read This Time Last Week!

Submitted by Reggie Middleton on 01/12/2011 13:21 -0400

This is the Facebook valuation exercise that I promised to release to the professional (HNW) blog subscribers ( File Icon FB note final).
As is customary, I am including a material amount for the public blog
to chew on. I think most will find it quite the engaging read, at the
very least. If you haven’t read my first three pieces on this topic,
please do so for you will easily be able to glean my overarching opinion
on this most recent Facebook “investment”:

As reported by Bloomberg,
the Facebook stock sale throws new light on the Goldman Sachs potential
conflicts of interest – conflicts which we have illustrated in full
detail in the past. By offering shares to its most favored clients and
forcing them to commit or decline in less than a week, Goldman not only
made investing in Facebook seem like a precious privilege from a
marketing perspective, but made due diligence nearly impossible for
those who did not have a dedicated staff with the free resources to
throw at the problem in near real time. We, at BoomBustBlog would like
to remedy such an issue as what I see is the new face of investigative
reporting and analysis on the web, and will offer consulting services to
HNW and UHNW clients who find themselves in similar binds in the
future. Simply drop us an email.

Goldman warns, ‘We’re probably going to dump this load, but we may also need you to remain behind to hold the bag!’

In its offer for the $1.5bn stock sale of privately held social-networking company Facebook, Goldman Sachs disclosed that it might sell or hedge its own $375m investment without warning clients. Under the deal, private
wealth-management clients would be subject to “significant
restrictions” limiting their ability to sell stakes while Goldman Sachs
own holding can be sold or hedged at any time, and without warning.
One would hope that astute clients and investors would be put on guard
by such conflicting and restrictive liquidity measures! In addition, it
appears as if Goldman Sachs failed to disclose its clients that
it had offered Facebook shares to its internal investment group, Goldman
Sachs Capital Partners, headed by one of its star fund managers,
Richard A. Friedman. Since 1992,
GSCP has invested its own balance sheet as a principal (that is, on
behalf of Goldman itself and its employees) in private equity and has
leveraged that investment through funds raised from its institutional
clients which include pension funds, insurance companies, endowments, fund of funds, high net worth individuals, and sovereign wealth funds.
Unlike most of its (and Wall Street’s) client orientated investment
funds, this vehicle actually puts a significant amount of Goldman’s skin
in the game (see Even With Clawbacks, the House Always Wins in Private Equity Funds for
an example of the implicit call option private equity investors give
these fund managers, absolutely free, and the perverse incentive to do
deals regardless of the investment outcome that the options create). The
most recent vehicle, GS Capital Partners VI, closed with $20 billion in
committed capital, $11 billion from institutional/high net worth investors and $9 billion from Goldman Sachs
and its employees. That breaks down to a 55:45 split, much too rich a
contribution from the GS side in order for them to play the games
detailed in Even With Clawbacks, the House Always Wins in Private Equity Funds.
Thus BoomBustBloggers should take note that GS Capital Partners VI is
the current primary investment vehicle for Goldman Sachs to make large,
privately negotiated equity investments in which they are serious about
actually making investment gains in, versus churning and overpricing in
the attempt to generate fees and bulge the bonus pool.

With this backgrounder in mind, be aware that GS Capital Partners rejected
the Facebook deal as inappropriate for its clients (its clients being
45% Goldman employees and Goldman’s own balance sheet girded for longer
term principal investment), in part due to valuation concerns. Mr. Friedman apparently has the very same valuation concerns that Reggie Middleton and BoomBustBlog hold.

Goldman attempts to circumvent SEC policy, or clearly signals that Facebook is to issue an IPO – or both!

The special-purpose vehicle (SPV) created by Goldman Sachs is yet
another demonstration of how the firm is giving the impression that it
is skirting SEC regulations. The SPV is intended to pool several
investors’ money into single investment vehicle to create the legal
effect of a single shareholder as each SPV is counted as single
shareholder despite several thousands of investors participating in the
vehicle. The SPV is an attempt by GS to skirt securities regulations
that require any company with more than 499 investors to meet SEC
reporting requirements. According to the private-placement document,
Facebook plans to increase its number of shareholders above 500 this
year which would force the social-networking company to begin disclosing
reams of financial information or go public by April 2012.

Facebook: Is it just a fad? Online social trends
are completely unpredictable. If a new trend comes along that would
start engaging people, then Facebook could become the old way of social
networking just as quickly as it became the new way (if not quicker).
It’s not as if it hasn’t happened already, ex. AOL, MySpace, Orkut and
Hi5. Facebook does have an advantage that its predecessors didn’t in
that they attempted to create barriers to entry for competitors with the
“Facebook connect” api (application programming interface) that allows
for sites across the web to authenticate through Facebooks user
community rather than have a user type in repetitive login usernames and
passwords. While this is an advantage in that it offers some barrier
and is quite popular, it is not an insurmountable barrier for if the
tide changes, all users need to do is enter one more username and
password combo to switch over to another platform.

A high profile IPO commanding a premium valuation before the trend
fades away is the best way to create excess proceeds from retail
investors. We don’t believe that the Goldman Sach’s investment
materialized to meet Facebook’s opex or capex requirements. The whole
idea behind the investment was to set a ground floor for a “knock ‘em
out of the ballpark” valuation in the eventuality of IPO and put Goldman
Sachs as a front runner candidate to manage IPO. An IPO of that order
would mean that Goldman has a chance to collect significant investment
banking fees which typically range between 4-5% of the size of a
flotation and to take part in windfall profits during a (successful)
IPO. With its $450m investment, Goldman Sachs would own 0.8% stake in
Facebook while Digital Sky Technologies with $50m investment alongside
its previous stake would end up with c10% stake.

Although, Facebook has lot of potential opportunities and is yet to
fully address (it has begun to implement some of the following) several
markets including mobile-ad market, ads on partner sites, the launch of
e-mail and location features, one has to remember before paying a 100x
PE multiple that the despite its cult monopoly status, as an operator of
a social networking site, Facebook operates in a highly vulnerable,
highly volatile market that is quite susceptible to changing social
trends. From AOL, to MySpace, to Twitter, to Yahoo to Facebook, we have
sign roaring fires and spectacular flameouts, sometimes within the span
of just a couple of years.

Facebook: A great social networking site for users but does it translate for advertisers?

Social networking websites are a great place to make new friends and
interact with old ones. However, from a revenue perspective they have
been lagging. People log into social networking websites to interact
with their friends and play online games, and its members as such appear
indifferent to advertising. According to industry sources, Facebook
click-through-advertising rates (CTR) are much lower than Google and
Yahoo, and even lower than its social networking peers, MySpace. Google
has CTR of 8% while MySpace’s has CTR is about 0.1%. Facebook on
comparison has just 0.04% CTR. Explanations for Facebook’s low CTR
include the fact that Facebook’s users are more technically savvy
youngsters and are better at ignoring advertisements. On MySpace users
spend more time browsing through content. While on Facebook, users spend
their time communicating with friends hence, diverting their attention
from advertisements. However, Facebook fares much better in video
content. According to a study, it was found that for video
advertisements on Facebook, over 40% of users viewed the entire video
compared with 25% for the industry average.

In addition, Facebook’s low CTR belies its best in category reach,
which compensates for the lower CTR. This is both a blessing and a
curse. Althouth the raw money does manifest from the larger numbers, the
fleeting and ephemeral nature of the nascent social media business
means there is really no way to know of Facebook can keep those numbers
or if it will go the way of AOL or Myspace.

Valuation

Despite having given its clients just a week to decide to invest $2m
as a minimum investment (word has it that due to demand, the effective
minimum was $5 million) and given the dearth of available information
about Facebook’s operations and financial condition, Goldman Sachs was
reportedly able to close the deal a day early. The overwhelming investor
response amounting to several billions of dollars for just a $1.5bn
stake sale is a clear sign of investor fascination with Facebook, or a
testament to the marketing fortitude of Goldman Sachs. The truth most
likely lay somewhere in between.

Given the dearth of financial information under scenario one, we have
estimated FB revenues based on subscribers growth and average revenue
per user, and have assumed constant profit margin.

To put the amount of optimism used in our analysis in perspective, there are 6,892,839,222 people in the world according to the US Census Bureau’s World Clock.
Facebook currently claims 9% of that world population. Take into
consideration a material percentage of that population are elderly or
very young, infirm, illiterate, poverty stricken or located in remote
rural areas and do not have iPhones and Androids, broadband connected
computers and Facebook accounts, and may not have these things for some
time, if ever. For the extremely optimistic benefit of the doubt, let’s
assume that all children down to the age of infancy, the infirm, the
illiterate and the Australian outback settlers all are frequent or
likely Facebook users. Even with this assumption, Facebook will have to
hit 65% of today’s total (as in the ENTIRE) world population (not
factoring in population growth/shrinkage) by c.2020 to justify anything
approaching a $50B valuation – and that’s assuming they captured 65% of
every single man, woman and child in the world along the way – not 65%
of those who have access to an internet connected computer.

Thus, it is highly unlikely one can legitimately factor in the type
of growth needed to justify the current Goldman $50B valuation –
particularly when you consider that Facebook’s growth is already
slowing!

I make this point in an attempt to illustrate the absurdity of the
valuation presented to investors as a once in a lifetime opportunity
that you have to make a $2-5 million valuation decision on in a couple
of days without audited financials. You may be able to make some money,
but the chances are greater that you will trail the average ROR or
outright lose a bunch of money than it is you will hit that grand slam.
Those Goldman clients would have been better off investing in
BoomBustBlog!

Those who wish to subscribe to our research services should click here! You can contact me, Reggie Middleton, here.
Professional & Institutional subscribers can download the full
Facebook valuation analysis, complete with several valuation scenarios
here: File Icon FB note final. And finally, and most ironically – here is the debut of Reggie Middleton’s BoomBustBlog Facebook page!

- advertisements -

Wed, 01/12/2011 - 19:33 | 871577 Hephasteus

Facebook will be doing this in a few years.

LOS ANGELES – Struggling entertainment site MySpace said Tuesday that it is cutting nearly half of its staff worldwide, or about 500 people, after an extensive revamp in October overhauled its look and allowed it to be run with fewer people. The cuts, part of a two-stage layoff plan, better position the site for a possible sale or spin-off by parent News Corp.

Mike Jones, the chief executive of MySpace, called the cuts "tough but necessary" but said they put the site on a path to profitability while making it more nimble and entrepreneurial.

A person with close ties to the site said that the cuts, combined with a previous round of layoffs and office closures in June 2009, would save more than $200 million a year. The previous layoffs eliminated about 420 jobs in the U.S. and 300 jobs overseas, and shut several offices abroad. For the latest move, MySpace said it will enter into ad sales partnerships in the U.K., Germany and Australia.

The recent relaunch focused MySpace on giving its users, mostly aged 13 to 34, more ways to consume music, videos and celebrity gossip. Before, MySpace tried to be an all-purpose social networking site like Facebook. MySpace recently said it is no longer trying to compete with Facebook.

Wed, 01/12/2011 - 18:07 | 871345 GottaBKiddn

Great article, Reggie, as usual.

I'm wondering if the Squid might be factoring in hyperinflation to string along suckers, er, investors, and keep them "faithful". If investors see soaring nominal stock prices they'll be bragging up their profits, and thereby drawing in more suckers, while in real adjusted terms they are actually losing money. The Squid scores all the way up, then turns, and sucks theirs hearts out on the way down. It's good to be the Squid.

Wed, 01/12/2011 - 17:50 | 871273 ATG

Bravo Reggie

Of course some of us said similar re GOOG at 85 Dutch Auction IPO on 19 August 2004

Wed, 01/12/2011 - 17:38 | 871234 semiconscious

facebook - tulips for the 21st century...

Wed, 01/12/2011 - 17:38 | 871230 Jessica6

The main advantage you cite - “Facebook connect” api - is one I specifically avoid. Admittedly it's because I'm paranoid enough about their datamining habits, which I fear may be a better source of revenue for them than advertising.

On the subject of active users I know several people who have multiple accounts, usually three: One for social respectibility - family, work, uptight friends and potential employers/insurance companies - one for drinking buddies and real friends, and one for mafia wars/farmville/other time-wasting games.

The ones I see on there everyday are ironically the least likely people for advertisers to make much money from - either they work in PR/Marketing, they're unemployed or Facebook is their political soapbox for the evils of whatever company or news item of the day has caught their attention.

Wed, 01/12/2011 - 17:14 | 871175 YHC-FTSE

I appreciate your efforts Reggie, you're almost always a good read (No caveats! :)).

It just begs the question, what do the analysts know at Goldman's that we don't? I'd guess nothing, & you're right on the money about advertising on "Friendface" - who the hell notices them? Maybe they're factoring in inflation for 2020, and $50B will buy a nice second hand car by the time the Fed has finished using up the last drop of ink on the planet.

The use of phrases like "Once in a lifetime opportunity", and time-limited offers. Aren't they old tricks beloved by 1970's double glazing salesmen? I can't believe that still works on some people.

Wed, 01/12/2011 - 23:47 | 872150 StychoKiller

You look like you could use some different-colored aluminum siding over your eyes... :>D

Thu, 01/13/2011 - 07:33 | 872494 YHC-FTSE

:). We had double glazing salesmen in the UK, and you guys had aluminium siding salesmen! Same species of con.

Wed, 01/12/2011 - 17:06 | 871161 Dr. Engali

Reggie you forget......valuation means nothing. It's all a game of hot potato.

Wed, 01/12/2011 - 16:44 | 871105 Titus

I have 5 logins on facebook, do they all count too?

Seriously though, fuck Facebook.

http://www.southparkstudios.com/full-episodes/s14e04-you-have-0-friends

Wed, 01/12/2011 - 16:05 | 870986 MarketTruth

So how does one CANCEL their account IN FULL and have ALL data removed forever if they decide to never use Facebook again?

Wed, 01/12/2011 - 15:58 | 870975 TideFighter

Again, the value of a FaceBook lead to a business is nil. The quality is shit and tracking is somewhere around 2003 Google. Reggie, I am a big, big fan. But forget the numbers, the quality of nil is the multiplier, not the quantity.

Wed, 01/12/2011 - 15:54 | 870946 Crack Daddy

Type in the name of any Hollywood star. You will see dozens of accounts set up with the same name using the same pictures. Facebook like YouTube does not enforce copyright laws. As soon as they go public they should get sued by everybody in Hollywood.

Wed, 01/12/2011 - 17:03 | 871154 Pants McPants