Did Microsoft Pay too Much for Facebook?

As reported earlier, Microsoft paid an astounding $240 million for a 1.6% share in Facebook. This deal implicitly values Facebook at $15 billion. But why did Microsoft pay so much? Is Facebook really worth $15 billion? Does Microsoft think that Facebook will go public and grow rapidly like Google, or did Microsoft buy into Facebook in hopes to acquire exclusive advertising rights on the platform?

Facebook is expecting to bring in $150 million in revenue this year, making it a sizeable company. However, MarketWatch reports that most young companies are usually valued to betwen 1 and 10 times their expected revenue, meaning that Facebook should be valued somewhere between $150 million to $1.5 billion, not $15 billion. Microsoft has valued Facebook at 100 times its revenue. Did it overpay?

Another way to examine the deal is through advertising. Using a very simple model eliminating all exogenous variables, we can look at Microsoft's purchase as a grab at Facebook's 49 million users. But when doing the math, it means that Microsoft paid $300 for the ability to reach each user on Facebook(much higher than the high of $100 per user paid right before the internet bubble -see MarketWatch Article). With ad clicks usually worth anywhere from 5 cents to a dollar, it means that Microsoft is hoping that each one of us will click on 300-1500 ads for its investment to break even. I don't know about you, but I don't plan on clicking on that many ads.

Although this investment may not look very promising for Microsoft right now, don't scoff at it just yet. There are a couple of reasons why this investment may pay off:

1) User Base Growth
The simple math that priced each user at $300 per user did not take into effect growth rates. Although Facebook's user base is only 49 million right now, it could grow much higher. MySpace is a good example, who boasts a user base of 73 million. And with the next billion users slowly getting access to the internet (especially with the diffusion of internet access in India and China), there could be a very large market that Facebook captures. If Facebook succeeds in these emerging markets, Facebook's value will increase, and Microsoft will have a much larger user base to advertise to.

2) More than a Social Networking Site
There are some industry rumors that Facebook may evolve into something much larger than social networking site. With many users checking Facebook everyday like it's their e-mail inbox, why wouldn't Facebook add full e-mail capabilities? If it did, it would drastically increase the amount of time spent on Facebook per user, meaning that ad revenue would likely increase.
Others believe that Facebook may evolve into an On-line Operating System, providing full features such as remotely saving documents, using programs on-line, etc. With over 660 programs developed on it's API by over 4,000 developers, we've seen a plethora of programs explode onto the site that we would normally expect to use on our local desktop. This would make it a full-fledged competitor with Google, Yahoo, Microsoft, and many other companies.

3) Learn from History
It could be possible that Microsoft is learning from its past mistakes. When Google's Search Engine was the next hot thing without a clear vision of how to generate any cash, Microsoft & Yahoo both had the opportunity to acquire it for a measely $1 million. Both refused, and now Google's market cap is above $200 billion. Big Mistake.
The Lesson: Not everything needs to have a perfect profit generating mechanism as long as it has a large, dedicated user base. As long as a company has loyal users, there will be a way to generate profits.


Read more about why some are saying the deal may be a bad idea here: http://www.marketwatch.com/news/story/microsofts-facebook-deal-makes-no/story.aspx?guid=%7B78F7D965-7474-4A82-BE79-063A36EEFB8A%7D