Participating In Asset Inflation Can Bite You In The Rear

I really wanted to use another word to end that headline but I am trying hard these days to keep this blog clean.

Anyway, one of the many things I’ve learned the hard way is that irrational valuations can come back to haunt you. It feels so good when someone says a business you own a big piece of is worth some huge number. But unless you cash out at that price, it’s not much more than a tease. And it can come back to hurt you in many ways. The thing you must know about financial markets is they are irrational at times, but they are rational in the end.

Microsoft may have inadvertently set off some serious asset inflation that may now come back to haunt them. As most everyone knows, they paid a $15bn valuation for a small minority investment in Facebook last year that included a business deal to rep a significant amount of Facebook’s advertising inventory. Silicon Alley Insider and Kara Swisher report that Facebook’s financials look like this.

2007 Revenue:    $150 million
2008 Revenue:     $300-$350 million
2008 EBITDA:      $50 million

So Microsoft valued one of the two leading social networking companies at 50x revenues and 300x EBITDA.

What message do you think that sent to Rupert Murdoch and News Corp? I’ll answer my own question. It told Rupert/News Corp that myspace (the other leading social net) was worth north of $15bn. I don’t know what myspace’s financial numbers are (if you do, please leave them in the comments). But here’s a guess.

2007 Revenue:   $500-600 million (considering google pays $300mm/year)
2008 Revenue:   $625-750 million (25% growth)
2008 EBITDA:     $50-100 million

If you apply the Microsoft/Facebook multiples to myspace, you get a business worth between $15bn and $30bn.

Now many think that myspace is not worth as much as Facebook and that Rupert/News Corp is trying to sell it at the high. I am not nearly as down on myspace as most people are right now. They have an audience that is different than Facebook’s. They have a very active music thing going on. They are about to launch a third party app platform that every major Facebook app developer is going to be on. That may very well supercharge myspace’s growth in 2008 the way Facebook apps drove Facebook’s growth in 2007.

I am not saying that myspace is worth between $15bn and $30bn . But I am saying that if you overvalue Facebook, you are also overvaluing myspace. And when the company you want to buy uses a myspace overpay to make itself less interesting to you, then you are the one who gets screwed.

What goes around comes around.

#stocks#VC & Technology

Comments (Archived):

  1. WayneMulligan

    Fred,You bring up some great points this morning. Just to touch on the first one, because asset valuation is near and dear to my heart (I’m a die hard Graham n’ Buffett value investor)…great quote from Buffett as to why markets seem irrational in the short term, but rational in the long term:”in the short term the stock market is a voting machine, in the long term it is a weighing machine”…I love how he equates short term stock prices to “popularity”.And with respect to Microsoft’s FB investment: I’m not sure if they could’ve kicked off some type of hyper asset inflation. For me it was pretty clear that this was a defensive move on Microsoft’s part – the company didn’t just lock in their ad deal with Facebook, but by investing at such a high valuation, Microsoft also made it so no other company could come along and acquire Facebook outright (well, they made it very difficult at least). So while I’m sure owners of start up social networks quickly reworked their DCF models to recalculate their pre-money valuation, I don’t think this particular investment could set off anymore of a troubling trend than we’re already seeing in private asset valuation in this space.Thoughts?-Wayne

  2. BB

    good points by both of you – I thought this summed up MSFT’s thinking pretty well….and though Zuckerberg may not agree, the internal dialogue that the writer assigned to him gave me a good chuckle…..

  3. EPK

    I think MSFT intentionally bid at such a high valuation to lock out any other investors (i.e. Google). For around 250 million they bought an option on Facebook that valued it so highly, that no one can reasonably buy them or merge with them. From what i hear, Microsoft itself pushed for a higher valuation than it could have reasonably participated at for specif icily the reason i mention above. I think it is for the same reason, that Yahoo shareholders would block/sue any News Corp merger, essentially saying that the transaction is in play money and will not ultimately benefit them.High valuations can sometimes be strategic and lock out the market…seems like Balmer/Gates were incredibly strategic in their thinking, and it will ll end up working out in the end.

  4. Thomas

    Clearly this was a defensive bid on Microsoft’s part. I am curious to know who the #2 bidder and what their price was in the FB auction. I’m guessing that had Google announced the investment into FB Microsoft and Yahoo! would’ve felt crushed.

  5. Xavier Vespa

    I agree with EPK, MSFT is simply locking up the market by over-valuing companies so that they stay out of reach of the competition. $44bn for Yahoo i s just too obvious. You don’t make money by writing checks!btw, I listened to this post using Blogbard, and I totally recommend it.

  6. Daniel James

    Is there any evidence that apps ‘drove Facebook’s growth in 2007’? I’d say it’s a mixed bag. My suspicion is that good old fashioned ‘social utility’ drove FB’s growth.

  7. howardlindzon

    I wrote last week that valuation is what matters in private markets…PERIOD. Greed is a difficult emotion to contain as is fear.This time its the large companies acting fearful not so much the little guy.Price always matters. In stocks rather pay up in exhange for added liquidity. In privates, all I care about is best price bacause of the lack thereof

  8. howardlindzon

    also…NOT Can bite you in the rear…BUT WILL bite you in the rear.

  9. Tom O'Leary

    Ok, I’ll say it. Ass.

  10. stone

    Biggest problem here for Facebook and others is equity compensation. Facebook must be giving out stock options that are valued in the many billions. How can a serious valley heavyweight accept that with a straight face? I’d tell young Zuckerberg and their board to “fly a kite” “take an accounting charge”.

  11. Harry hvostov

    Apples and oranges comparison here.Problem: Business valuation is in the “eyes of the beholder”. A large corporation like Microsoft may look to realize some significant synergies through acquisition, hence the high multiple.A financial buyer approaching your private firm, may well be looking for a low cost income stream instead. Being savvy, these buyers are unlikely to be stirred into action by the lofty multiples used by Microsoft.In other words, your “highest and best buyer” may not be Microsoft.The moral is that selling any business at a top price requires thought and preparation. Part of this process is identifying who the right buyer is (and how much they would be willing to pay for your specific business).