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

Move Over Wall Street, the Technology Sector is Back

Amidst the crunch crunch due to subprime mortgage woes for investment banks, technology companies seem to be increasing sales by leaps and bounds. In the 10 days alone, we've seen Google and Microsoft beat market expectations on their quarterly results, which has translated into sizeable stock increases of 7.96% and 17.7%, respectively.

Increased on-line advertising, PC sales, video game sales, and general faith in these two large companies have increased investor confidence in the technology industry. All this amidst subprime mortgage woes, which have caused most of the major banks to report tremendous losses (see Merrill Lynch's $8 billion loss a few days ago). Stock Prices of Merrill Lynch, Morgan Stanley, and the Lehman Brothers have all fallen drastically in the last 10 days.As you can, these falls range from -6% to -16%, with Goldman Sachs being slightly above the rest with a -1.21% stock dip (believe it or not, Goldman Sachs actually beat analyst estimates and recorded a great quarter in lieu of the market downfall).

These trends lead me to pose the simple question: Should we, as short-middle range investors, be moving our money into the technology industry and away from the financial industry. I say yes, but that could be because I'm a tech geek.

Microsoft outperforms expectations, Stock Price Jumps!

On October 25th, Microsoft announced their first quarter earnings, notably outperforming the market's expectations. Revenues came in 27% higher than last year at around $13.9 billion, beating Wall Street predictions by approximately $1 billion. Operating Income also saw a big increase of 32%, coming in at $5.9 billion.

This represents a big quarter for Microsoft, and shows that it still has the guns to compete with the likes of Google. After it's earnings call, it's stock price increased by more than 10% in after hours trading, representing it highest stock price since 2001. This is an extremely big win for Microsoft, as its stock has remained relatively stable while its competitors stock prices have been consistently increasing.
Microsoft is represented by the blue line, with it's stock price increasing 45% in the last 6 years, while Yahoo stock has almost doubled, Google's stock has risen 520% since its IPO in August 2004, and Apple's sTock has risen 2500% (thank you Mr. Jobs).

It's high revenue can be attributed to extremely high Halo 3 sales (generating $300 million in revenue this quarter), unexpected Vista Premium sales, increased Vista sales in international markets, and increased PC sales. Microsoft has also cut prices on its popular Xbox 360 console, and has recently bought a small equity stake in Facebook, hoping to increase its ad revenue. In addition, Steve Ballmer announced that Microsoft is ready to acquire 20 companies a year for the next 5 years, looking to expand it's already large empire. With a market cap of $331 billion, it is now almost twice the size of Wal-Mart.

It seems that Microsoft may be back in the game with Google, as it has increased its fiscal year projections for revenue, expecting approximately $59 billion in revenue for the year.

Details of the Microsoft & Facebook Deal

As mentioned in previous posts, Microsoft won a 1.6% share of Facebook for a whopping $240 million, signing a deal to that allows Microsoft to take care of Facebook's advertising for international users.

This represents a major win for Microsoft, whose web advertising is a fledgling baby compared to Google. With 60% of Facebook's 49 million users being abroad, Microsoft has just gained access to 29.4 million users who post detailed information about their likes, preferences, books, movies, music, etc. This data repersents an advertising bonanza for Microsoft. The deal guarantees that Microsoft will retain the rights to advertise to international users through 2011, essentially keeping Microsoft in through Facebook's soon-to-be IPO and its first couple of years as a public company.

Google declined to comment, but did mention that they would soon allow Facebook's 4000 developers (who use Facebook's API's) to gain access to Adsense, essentailly allowing Google a backdoor entrance into Facebook.

It also seems that MySpace should have waited to sell their company, as they only received $550 million from Fox in 2005, and have a much larger user base of over 70 million. Google currently advertises on MySpace.

While some analysts are worried that Microsoft paid too much, I believe that Facebook will continue to grow. Expect Facebook to go public soon, and Microsoft's ad revenues to increase.

Final: Microsoft buys a 1.6% share of Facebook

This afternoon, Microsoft beat out Google to buy a 1.6% share of Facebook for a whopping $240 million, implicitly valuing Facebook at $15 billion. With Facebook's large user base of over 41 million, this could help Microsoft kickstart its lagging advertising network. Microsoft will handle Facebook's international advertising.

Though Google lost it still has a large piece of the social networking market, as it owns Orkut and provides ads for MySpace (the largest social networking website with a user base of over 70 million).

Facebook is rumored to be thinking about issuing an IPO, even as early as next year. Will Facebook be the next Google in terms of public offering? Only time will tell.

Update: Facebook nears deal with Google or Microsoft

A report from Reuters claims that Facebook is nearing a deal with either Microsoft or Google to handle its overseas advertising sales. Analysts estimate that a bid from either company would value FaceBook up to $15 billion.

Read more about it here:
http://www.reuters.com/article/mergersNews/idUSN249109020071024

Facebook seeks Valuation between $10 to $15 Billion

It seems that 23 year old Mark Zuckerburg may be on top of the world as his company, Facebook, is seeking a valuation between $10 to $15 billion. Facebook is a popular on-line social networking site, boasting a user base of approximately 40 million people. Rumors have shown that Microsoft, Google, and Yahoo are all interesting in buying a piece of the firm. Earlier this year, Yahoo bid $1 billion, MSFT bid $1.3 billion, and more recently, there have been rumors of Microsoft bidding $500 million for a 5% stake. Interestingly enough, MySpace has a larger user base (around 50 million) and sold itself to Fox for $550 million in 2005. It's too bad that MySpace didn't wait a little - think of how much more money they could have received.

Even though Microsoft and Yahoo have already put in bids, don't rule Google out. Even though Google has an internationally popular social networking site in the form of Orkut, Google has expressed interest in Facebook. It would be very easy to imagine a syndication between Facebook and Google's AdSense.

However, it is plausible to think that Facebook may want to go Public. With a valuation of $10 billion, it would start at 1/4 the current size of Yahoo, with only room to grow. Some are even speculating that Facebook could even develop into an online Operating System, as many programs and widgets have already been developed. If this were the case, then Facebook would start directly competing against Google, Microsoft, and Yahoo.

Why Facebook profit will continue to grow:
1) Open Platform: Since publishing the facebook API earlier this year, more than 4,000 applications have been developed by Facebook. Free developers are always a good thing!
2) Large User Base: Facebook has over 40 million users, with the average user spending 3 hours a month on Facebook. Each user also posts detailed personal information about themselves, including hobbies, favorite movies, music, bands, sports, books, etc. Multiply all these factors, and you'll find that this is an advertiser's dream!
3) Network Effects: As the user base gets larger, more users will join in order to be connected to their friends. This poses an interesting barrier to entry for potential new entrants, as a smaller user base will make it harder for other social networking sights to grow to Facebook or MySpace's size.


Could Facebook be the next Google?

Is M&A the only way to Win?

In a brief Q&A at the Web 20. Summit Yesterday, Steve Ballmer said that Microsoft would be willing to acquire up to a 100 companies in the next five years. That' would spell out to be a spiraling acquisition game, which could wreak havoc on its financials. But more importantly, how does this fit in with the industry?

Microsoft has been the behemoth in the industry for the past 20 years, but many analysts point to a stagnant stock price and unpopular news media to make the claim that Microsoft may have matured. Compare Microsoft with Google, who's stock price has increased nearly 500% since it's Initial Public Offering in 2004. One way to compare the companies may be to look at sheer size alone, with the time-tested Microsoft boasting a market cap of $283 billion, and infant Google passing the $200 billion market cap mark just a few days ago. Do you think Google is big yet? Well, dig a little deeper and look at the number 3 and 4 search engines Yahoo and Baidu, who boast much smaller market caps of $38 billion and $10 billion, respectively. Most analysts are bullish on Google, while remaining neutral to the industry.

Some may ask how Google has grown so big? One way to answer this question may be to look at Google's acquisitions. Google has done a good job of acquiring horizontally related software development companies, acquiring more than 40 companies since 2001. This works out to approximately 7 companies a year. These companies have added significantly to Google's product line, including Youtube, Docs & SpreadSheets, Maps, and more. Maybe Microsoft sees small, innovative companies as the best method of increasing research and development? It does seem that way, especially if Ballmer wants to acquire 20 companies a year for the next five years. I predict that we will see higher P/E ratios indicating higher expectations for MSFT.

The real test will be if Ballmer can pick the right companies. Acquiring companies requires a lot of thoughtful planning, and acquisitions only work if the acquired company fits into the bigger picture of the acquiring company's strategy. Let's see how Ballmer does.

Link to Article:
http://blog.wired.com/business/2007/10/microsoft-wants.html