You have heard me go on before about why I thought the valuation Microsoft gave Facebook for its "strategic investment" was way out of line (nice way of saying absolutely ridiculous). Below please find analysis by Daniel Primack (of PEHub fame), which I think is spot on, so simply reposting in...bottom line, Dan thinks that "Microsoft’s initial investment may be one of the worst venture capital deals of all time."
Not only do I agree, but want to add that in addition to being terrible deal for MSFT, also sent shock waves through the entrepreneurial ecosystem, even here in Israel, which made entrepreneurs (and some VCs and Angels) silly for several months. All of a sudden every idea for a new social network was deemed to be worth $5 million pre-money...which is one of the reasons Jerusalem Capital did make any new investments since September 2007.
We already see that people have come back to reality, a bit. Anyway, here's Dan:
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| 1191 articles posted | contributor since 11/2006 |
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| Facebook’s Valuation Problem | ||
| Topics: VC Deals, PE-Backed M&A, PE Exits | This entry was posted on 05-09-2008 | |
The WSJ recently reported that Microsoft is sniffing around Facebook, less than seven months after investing $240 million in the social network at a $15 billion valuation. It was largely discounted as the hopeful fumblings of Steve Ballmer, in his search for a rebound acquisition after being dumped by Yahoo. But it got me to thinking: Microsoft’s initial investment may be one of the worst venture capital deals of all time.
Longtime readers know that the current title-holder is Hummer Winblad, for its Napster investment in the midst of that company’s legal morass. And it will remain that way, as Microsoft’s Facebook deal presents neither the legal difficulties nor the likelihood of a total write-down. In fact, it’s probably been a good strategic deal for Microsoft, which doesn’t need to sweat the small stuff (i.e., cash). The only caveat to that last part is that Microsoft is now expected to overpay for all its other acquisitions, which has led to a trickle-down throughout the Web 2.0 market. For example, macro valuation inflation helped scuttle the Internet roll-up envisioned by Ross Levensohn and Jon Miller — as their targets upped their respective asking prices.
Anyway, back to my thesis. The reason this might be one of the worst VC deals is that all of its negatives fall on its supposed beneficiary: Facebook.
This isn’t a dilution argument, but rather one of public perception. Social networks partially work because of functionality, and partially because of bandwagon popularity. You don’t necessarily join and use Facebook because it works well, but perhaps because your friends have joined and use it. And, as has been proven with MySpace-Facebook-Beebo, that usage can be fickle and prone to migration.
Public perception is very important, and I think the Microsoft investment has set Facebook up for a giant egg pie in the face. For example, imagine the endgame is to go public. If so, there is no way a company with such low revenue could possibly get near a $15 billion valuation (this isn’t 1999, and Facebook isn’t Google circa 2004).
So let’s generously imagine it could get $5 billion. Know what the headline will be? How about: “Facebook Files for IPO.” Looks good, but check the subhead: “Social networking company worth just one-third of 2007 valuation.”
Ditto for an acquisition, as no company in its right mind would pay close to $15 billion for Facebook. Yes, that includes Microsoft.
What this means is that Facebook is going to lose heat upon liquidity, and a loss of heat can lead to a loss of cachet. Remember all the buzz when Facebook got the $15 billion? Now imagine it again, but with a negative spin (particularly outside the TechMeme bubble, where most of Facebook’s users actually live).
All of this is exacerbated by the fact that Facebook never really needed to take the Microsoft money (could have gotten it elsewhere), and certainly didn’t need to confirm the valuation in a press release.
The only out I see for Facebook is to take another big strategic investment at the $15 billion figure. It could provide liquidity for Facebook’s early VCs like Accel (whose LPs would really like some payoff) and other employees looking to turn their paper green. And, yes, that probably means Microsoft again. If not, that original investment will hurt Facebook far more than it will help it.
Note: Much of the above argument was first made (to my ears) by
venture capitalist Stewart Alsop, at this year’s VC in the Rockies
conference. It took my a while to come around, but I’m now there. Hope
he doesn’t mind the pilfering.
Facebook may have been silly to accept such a valuation, but a quarter billion dollars was probably worth it for a foot in the door of what is, after all, the Holy Grail of Web 2.0: The single sign-in.
I discovered this when it came time to upload graduation pictures and videos to share with the grandparents. If I upload to Snapfish or Flickr, my parents need a password, or I have to forward a particular URL, or the pictures will be public. Facebook promises one account which lets my parents and cousins -- but not random strangers -- see the cute pictures and video. So while I'm sure Flickr and Picassa offer better features, I'm sticking to Facebook. And pictures of the grandchildren will be the killer app that makes my mom sign up.
Why is this important? Let me give you an example from my line of work: Publishing. There's a problem with e-books. How do you impose a reasonable license on an e-book, so you can read it on your iPhone or Palm, and maybe even lend or give it to a friend -- but not have it circulating freely on usenet?
Clearly, linking an e-book to a user is a solution. (Kindle solves the problem in its own way, but neither users nor publishers want their books to be locked to an Amazon-owned device). I'm sure that's the idea behind Adobe's new Acrobat.com PDF site. But another password for e-books? Feh.
Enter Facebook. As Facebook heads toward 100% penetration, associating one's e-book library with one's Facebook identity makes a lot of sense. I suspect that for MS, owning that identity piece rather than any IPO end-game was the point of the purchase.
Posted by: Larry Yudelson | July 03, 2008 at 04:13 AM