Facebook Valuation Proven at Zero Dollars

I'm getting extremely tired of hearing the media and lots of really smart people refer to Facebook as being worth fifteen billion dollars. Not because I don't think Facebook is worth $15 billion.

It very well might be, even though with their about $100 million in 2007 revenue that's a 150x multiple on revenue, only about 10 times out of scale from the other most successful companies in the hottest software sectors right now.

What's killing me is the fact that everyone is arriving at this incredible valuation based on flawed logic. As the New York Times reported in October of 2007, Microsoft made a $240 million investment in Facebook and in exchange received a 1.6% ownership position in the company. If you scale this up (240/X=1.6/100) by solving for $X = (($240 million * 100%) / 1.6%) you do reach a big nice round number of $15 billion. Maybe the math worked out too perfectly for anyone to look any deeper into the situation or maybe people wanted Facebook to be worth $15 billion. Whatever the reason, the logic isn't there.

From day one Microsoft approached the deal as an investment in extending the reach of their advertising platform. But this deal has been publicized as a cash-for-equity purchase, so how does that extend Microsoft's ad network real estate?

The answer is in the much neglected fact that the deal wasn't about cash in exchange for stock, it was for stock and a multi-year exclusive right to non-US advertising real estate on the Facebook platform. The original New York Times article mentions that "As part of the deal, Microsoft will sell the graphical banner ads appearing on Facebook outside of the United States, splitting the revenue. "

So, in addition to 1.6% of the company's stock Microsoft also purchased many billion advertising impressions over a number of years that they can sell to publishers in their ad network and they can keep 1/2 (or maybe another percentage, this isn't clear by the wording I've seen) of the revenue for themselves.

For this exact reason it was widely publicized that Google and Microsoft were dueling for the right to make the investment in Facebook, in much the same manner that the two fight over online advertising market share already. As many who watched the deal go down said, Microsoft simply could not afford to lose the relationship with Facebook considering their distant second place to Google already in publisher adoption among their ad platform.

In consideration of Microsoft's desperation they may have had little interest at all in the equity position they received, further tipping the allocation of the $240 million toward the value they will receive from the advertising inventory reach and revenue share.

Furthermore, as the New York Times mentioned, "Microsoft has an existing deal with Facebook to run banner ads on the site in the United States through 2011" which implies that an existing relationship with Facebook might have been challenged in some way had Microsoft not stepped up to the plate to nab the non-US advertising inventory, especially so if Google had secured it instead of them.

After the deal closed Microsoft was very positive about the potential inventory reach and revenue share value of the new international ad inventory on Facebook. As the New York Times reported "In a conference call with journalists and analysts, Kevin Johnson, president of the platforms and services division at Microsoft, described the deal as a “major advertising syndication win for Microsoft.""

The real question behind all of this is, what is that worth to Microsoft? In fact, if it's worth more than $240 million then technically Facebook should be valued at $0 using the same logic and math applied to calculate the $15 billion valuation (ie: $240 million = A + B, if A = 1.6% of Facebook's stock and B = Microsoft's share of non-US advertising revenue, then by simple logic if B = $240 million then A is equal to 0, then if 1.6% of the company is worth zero notwithstanding rounding error then 100% of Facebook is worth $0 via the scaling equation I outlined earlier). It's even more fun to consider that revenue value to Microsoft being greater than $240 million.

As you scale the value upwards Facebook's value becomes increasingly negative. So, assuming the deal will be cash flow positive to Microsoft (or discounted cash flow positive) then if you believe Facebook is at least worth $1 then you negate the fact that it could be worth $15 billion.

I guess it was appropriate today that "news" site The Register, with tongue appropriately pressed to cheek, reported an astronomical drop in Facebook's value per Facebook's recent approximations of their own value in court papers related to the ConnectU lawsuit. By their logic, nicely stacked on top of the flawed logic I've discussed above, Facebook lost $11.25 billion in value just during the day today. Talk about a recession!

That seems like appropriate punishment for all the shenanigans the media has had in doing the math on Facebook's valuation to date. At least now with Facebook's approximation of their own value the media will finally have another good data point that they can completely ignore for the sake of a good whiplash headline.