Last weekend bankers, including Goldman Sachs’s big guns, were actively courting GroupOn to lead its speculated IPO this year. This week Goldman (again) announced that it had raised a US$ 1 billion fund to invest in Facebook from non-US investors. This, along with the US$ 500 million the firm itself and Russia’s Digital Sky Technologies have invested, puts the value of Facebook at around US$ 50 billion. You can be excused for thinking you are in a time warp. No, it’s not 2000 again, although those who experienced the internet bubble may be excused for a quick double-take. I don’t want to be a party-pooper, but is it “bubble or no bubble” as we look at these enormous valuations? Is Facebook really worth more than media giant Time Warner (market cap: US$ 36 billion) or internet veteran Yahoo (market cap US$ 21 billion) – or the equivalent of one sixth of Apple, one quarter of Google or two-thirds of Amazon?
Despite the continued sluggishness of developed world economies, stock markets are rallying and the bulls are out, promising a good year. Institutions are back in equities and emerging markets look good, so everything is rosy… right? It doesn’t quite fit with the real world as some nations tackle spiraling national debts and others the threat of inflation and over-heating, while some market watchers such as the FT’s John Plender suggest it’s a time to look for the least bad investments.
The big difference versus 2000 is that both GroupOn and Facebook have revenues and profits – although given both are (currently) private, numbers are hard to come by. More is coming out on Facebook as Goldman’s investment memorandum gets wider coverage: Reports suggest Facebook realized $355 million in net income in the first nine months of 2010 on revenue of $1.2 billion. We won’t know more until Facebook opens its books which will be no later than April 30, 2012, according to a statement detailing the new investments. It may however move sooner to avoid regulators querying the less than 500 shareholder rule, as private firms with 500 or more shareholders of record have to publish quarterly accounts and audited financial statements. Goldman switched its fund from US investors to non-US investors to avoid such queries (no doubt to the irritation of US investors wanting a slice of the action). Most companies that hit this limit seek a public listing, for example Google, where the rule tipped it over the edge to an IPO in 2004. So suggestions are that Facebook will launch its IPO in early 2012, but we shall see.
The relative imbalance between the reported revenues/earnings and the valuation means that the US$50 billion valuation was not reached with “traditional” net present value analysis – not unless there are some pretty big assumptions in place on future earnings streams and/or innovations. A P/E ratio approaching 100x does make me think vividly of 2000… So, obviously someone has a master plan to maximize value from Facebook’s internet “real estate,” to build a sound commercial business model. The first question on such a business model (at least if you are an investor) is what is it based on? Advertisers love Facebook’s captive audience, brands are building online stores, and the company itself is experimenting with many innovations from location-based services to becoming a recruiting medium. Some of these will no doubt work commercially, but it is hard to tell which will be the big drivers of value since commercializing social networks is breaking new ground. While Facebook may well be worth US$50 billion (or more) at some point in future, as a result of much hard work and innovation in value creation, how much of this hard work and innovation is already factored into the estimated value today, i.e. if I invest now, do I have an upside based on business fundamentals rather than “irrational exuberance”? Another critical question is whether the social community itself will be happy with the increasing commercialization of the network. Can Facebook maintain the balance between “social” and “business”? Obviously the bankers and investors think it is possible, but it would be very interesting to see what the community itself feels – opinions very welcome.
As for GroupOn, which has around 35 million users, its announcement in December that it planned to raise US$ 950 million in new equity put the company’s value at around US$ 7.8 billion, just a few weeks after it had rejected a US$ 6 billion takeover bid from Google. While GroupOn’s business model means it takes a large percentage of the revenue on every offer where it delivers the specified number of buyers to a client, there is one (not so small) thing that has been glossed over by all the hype surrounding the company: At the start of last week it had at least one sizeable and well-funded competitor in the shape of LivingSocial, in which Amazon has invested US$ 175 million. The link can be seen in LivingSocial’s offer this week of an Amazon US $20 gift card for US$10. A little muscle-flexing as GroupOn courts the bankers?
By the end of the week, GroupOn had at least two sizeable and well-funded competitors: Google appears to have said, “If we can’t buy it, we will just do it ourselves.” Google Offers is reportedly in testing right now and made the press this week. GroupOn may be the poster child right now, but there are a couple of 800 pound gorillas looking for a share of the action. Which brings us once again back to the question of valuation. GroupOn’s business model is innovative and delivers real earnings – but the barriers to entry are pretty low, and the returns are attractive. Hence competition is only likely to increase, particularly from businesses such as Amazon and Google which have extremely large user-bases, about which they already have plenty of data to mine to both source and target offers, plus huge technology expertise which could allow them to innovate further and faster than GroupOn. If I was a current investor in the company, I would probably want the IPO sooner rather than later – and not have my shares locked up, as again the potential parallels to a decade ago are too close.
Ultimately, is there a bubble in the making around the new generation of internet-fueled businesses? It’s not clear yet because these two companies have broken new ground, created new markets, invented new business models and may ultimately drive yet more successful innovations. Clearly they are both exciting and it is understandable to want to be in at the start of a potential investing boom. For me, I am happy to watch on the sidelines for now – there are too many open questions. If you want to take the bet, hope it works out for you, but don’t put down the deposit on the Caribbean island too soon…
