Those of you who remember the heady days of the dot-com boom circa 1999 will have a queasy feeling - the kind you get at the top of a roller-coaster - when you hear that the management at Facebook think their business is worth between $5bn and $6bn. The team running the social networking platform is soliticiting additional private equity funds at the moment, but the firms it has approached are putting a more conservative valuation on the company - between $2bn and $3bn.
The crucial piece of information here is that Facebook is not yet cash-flow positive - it’s eating up capital ploughed in by existing investors to keep going. And that “cash burn” is the stuff of the original dot-com boom. The business model back in 1999 was to spend as much money as possible to “acquire” users for your web site, and then worry later about monetisation.
I wrote an article for Financial Director magazine at the time, about the pros and cons of this approach. Many of the original dot-com investors who failed to find buyers for their internet plays before the bust in 2000/01 were left with worthless stocks. So it’s no surprise to hear PE firms playing hardball with Facebook (which also, incidentally, is facing something of an investors relations challenge with the existing stock-holders who pumped $400m into the business and are now facing a dilution of their equity…).
But some of those original dot-com plays have made it big. So might some of the Web 2.0 businesses actually be worth astronomical valuations? Google (current market capitalisation: $126bn) was too insignificant to have made it into my article ten years ago. But Yahoo! did feature. Market cap then was $36bn; today, $20bn. Ouch. (OK, we can quibble about inflation and other adjustments including any dividends, but that’s still a mighty drop.)
Others have fared better. Ebay? Worth $21.5bn today, $3bn more than 1999. Amazon? A decade back, $20bn compared to today’s $34bn. That’s impressive, especially in the wake of the stock market falls of recent months. So what’s the difference between the winners and losers in my crazily small sample?
Simple: transactions. Ebay and Amazon sell things. By definition, users of their sites hand over cash. Even if their margins are wafer thin, the huge number of sales means they’ll make a profit - and more importantly, they generate a lot of cash-flow. We’re talking serious amounts: Amazon’s income for the quarter to end December 2008 was $645m - but its cash-flow from operating activities was $1.6bn.
Facebook’s problem is that it simply doesn’t have a convenient way to dip into that river of cash running through the web. Sure, Google has made a ton of money from serving tailored ads to users. But while Facebook basks in the glory of more than 200 million users, everyone (well, almost) uses Google, and probably a lot more frequently than they stop by Facebook. So the ad revenues are never going to be comparable. When Facebook has attempted to monetise its popularity in other ways - setting up polling applications, for example, based on members’ profiles - it’s faced a backlash from users.
The management team there will probably crack monetisation eventually. But that “probably” - and the experience of the dot-com boom ten years ago - means the private equity chaps are right to play hard-ball on the valuation. At $2bn, the company looks like an interesting punt. But $6bn for a cash-flow negative business? That’s a “boom-bust” number.
