02/14/2012 12:20 pm ET Updated Apr 15, 2012

Valuing Facebook and Its 800 Million Customers: A $100 Billion Option on Unknown Future Strategies

  1. How do you value a company like Facebook?
Probably the most reliable way to value a new company is the technique called mark to like. When a company is too new for its current size, its current revenues, or its current profits to serve as an accurate indicator of its value, we look for the most similar company we can find and start the valuation there. That provides the like. We take the value of the like, and then adjust it up or down to assess the new company that we are trying to value.
  • Does the new company enjoy a market that is potentially larger than the like? Will its market grow?
  • Does the new company already enjoy a bigger share of its market? Does it face dangerous and powerful competitors, or will its share grow?
  • Does the new company serve more concentrated and powerful customers, or are its customers small and independent?
  • Does the new company rely on a more complex distribution system than the like, or can it reach its customers more easily and more directly?
Sometimes the answers will make us place a larger value on the new company than on the like (since the market for search at Google is larger than the market for airline reservations through Travelport, all other things considered, the value of Google should be larger than the value of Travelport). Sometimes the answers will make us place a smaller value on the new company.
  1. Has there ever been a company like Facebook?
Is Facebook completely new? Is it an online version of something we have seen before? Or is it something in between?

Not much of anything, anywhere, is completely new. Still, after 15 years, ecommerce is used mostly for the selling of traditional goods and services. Online commerce is not about selling frisky electrons (or frisky photons, actually); it is still about selling the goods and services they describe. Perhaps the truly e-est of today's online apps is World of Warcraft, where people who have never met, meet and cooperate on complex quests to achieve tasks, that, well, don't exist.

Facebook may not be as purely e as we once imagined online commerce would be, but it certainly is cool. About 800 million people use Facebook to communicate, to keep in touch, and to share photos, stories, and updates on their activities. They use it to communicate their likes and dislikes about ideas and companies and products. And increasingly they use Facebook instead of phone, email, texting, and other forms of messages to coordinate their activities in real time. Facebook may have started as a way to find a classmate or learn what a classmate did, but it is turning into a mechanism for coordinating activities and deciding what to do. This encompasses anything from coordinating a group's activities or finding a date to planning and executing a revolution and overthrowing a government.

But how much of this is new? Social networking itself is not new. As humans we have been networking since, well, before we were human. Our closest living primate contemporaries have social networks, and our proto-human and pre-human ancestors must have had social networks as well.

Online social networks are new. And the Facebookification of the planet may be new. It has already led to changes in dating and changes in social interaction. Social psychologists talk about herding replacing dating, where young people congregate more as groups than as couples. Most strikingly, Facebook is helping to produce a generation that is never, ever, alone and never, ever, out of touch.
  1. So what's the like?
What company or companies can we use to construct the value of Facebook? What's the like? What is Facebook about?

What does Facebook do? More importantly, what does it allow us to do? How do we use it? How do we want to use it and how will we use it in the future?

Obviously we use it for entertainment, for communication, and for rapid sharing of information and images. So that suggests we start with an entertainment company, a communications company, and a "moving stuff rapidly" company to provide our first attempts at the likes. As an entertainment company, let's start with Disney, with a market capitalization of about $72 billion. Let's use Verizon as our communications company, with a market cap of about $107 billion. And as a moving stuff rapidly company let's look at Federal Express, with a market cap of about $30 billion1.
  1. Now what do we do?
Now that we have a collection of similar companies, or at least companies in the same industries, to start our calculations, what do we do next? Can we start by just summing up all three market caps? That would give us close to $200 billion in potential value when Facebook matures. That's probably too high. In part, Facebook shares these markets, since time we spend on Facebook is probably time we are not going to see Toy Story 4 or 5, or watching ESPN, and probably not time we are texting our friends or talking to our parents with our cellphone. Facebook is a blend of these three companies, and partly it is a competitor. Viewing Facebook as a blend, we might just start by averaging the value of the three companies we selected as likes. That would give a value of $67 billion. However, Facebook is not done growing and it is not done growing these three markets. The value of $67 billion would therefore be too low. If we use a conservatively low multiplier of 1 ⅓ to account for future growth in Facebook's participation in all three markets that would give us a valuation of $100 billion, almost exactly the value currently projected.
  1. Not so fast
But does this approach really make sense? Are these apparently comparable companies really comparable at all? Disney makes most of its money selling movie tickets, movie DVDs, and tie-in movie products. Only a small fraction of its profits come from ads. Facebook is different from all three, with a different business model and a different revenue stream. I can't see us giving our kids a Mark or Randi Zuckerberg doll as a birthday or holiday present. Likewise, Verizon makes most of its money selling us bandwidth, not serving us ads. And of course Fed Ex makes its money moving stuff around, such as packages and urgent documents that for some archaic reason need to be seen and signed in their original form. Again, their revenues and profits do not come from ads. So maybe these are not the right likes yet.
  1. And while we're worrying ... will users accept this business model?
Even if an entire generation believes, now, that privacy is dead, it may not be dead forever. Indeed, as this generation ages, as the implications of having a permanent online audit trail become more clear, privacy may reemerge as a central concern. Personal information, naively shared, remains online indefinitely, and as the history of how this information can be used years or decades later becomes more clear, privacy may indeed be a significant concern. If Facebook's value proposition and revenue streams mostly come from tracking their users most intimate relationships, recording this information, and monetizing this information, how will this affect the company's success? How will it affect their ability to compete in entertainment, communications, and rapidly moving stuff? How will concerns about privacy affect the valuation of a company whose revenue stream and business model rely upon monetizing personal information?
  • What if Disney tracked, forever, every movie I saw and every product I bought, and everyone I saw the movies with? Actually, this is probably OK. It's hard to get safer than taking your own kid to see The Little Mermaid. There are unlikely to be any X-rated skeletons to worry about later.
  • What if Verizon taped all of my interactions, both voice and DSL-based? What if they did this without needing a wiretap authorization? What if I could lose my job for something stupid I said over the phone? What if I could really piss off a family member, or a spouse, with an unguarded word or two over the phone? What if I changed my mind, a week later, or a year later, about how I felt about my family member or my spouse hearing those unguarded words? More significantly, how would I feel if the monetization of this information became the value proposition and the business model for FedEx, if regulation were largely absent, and if I had little or no control over how information was used later? Is this really the basis of a communications company?
  • We can ask the same questions about FedEx. What if they recorded everything you bought as a
So there really is a big difference between Disney, Verizon, and FedEx on the one hand and Facebook on the other. These companies make their money serving us. Facebook serves us, but it makes its money elsewhere. It makes its money tracking us, and then using the results of the tracking to allow others not so much to serve us as to serve us ads. Is this morally acceptable? Why not? If the kids who use Facebook (i) know what it's doing (they seem to) and (ii) it's OK with them (it seems to be at present) and (iii) if they know what can happen if they post things now that will haunt them forever, like a poorly thought-out tattoo for a long-gone lover (they don't seem to know or care), then why not? A business model based on selling the privacy of people who don't yet know or care what this will mean in future may not be what I expected from a crusading hacker who claims to be more concerned with changing the world and serving his users than with revenues. It may not be in the best interests of its users, but it may still be an acceptable business model if its users don't care2.
  1. Assuming that users will accept this business model, is it working?
But more importantly, is this business model working? If Facebook is an ad company, is it an extraordinarily successful ad company, worthy of an extraordinary valuation? That really is the more interesting question right now. Facebook reported $4 billion in revenue from 800 million users. $4 billion certainly sounds like a large enough revenue value for a start-up, when compared to the numbers reported by IPOs during the run-up to the dot-com collapse. But with 800 million users, Facebook is not exactly a start-up. They have had time to show us how well they monetize their users. So it's reasonable to ask how their revenue numbers compare to the companies we selected as comparables.

Verizon reported revenues of $106 billion, almost exactly the same as its market cap. By that measure Facebook's valuation should be $4 billion. Now we need to expect Face book to grow its user base or its revenues per user by a factor of 25. Increasing the user base by a factor of 25 would require Facebook to have more than 20 billion users, or more than the total population of the planet, which is clearly impossible. Alternatively, to be valued at $ 1000 billion as a Telco they would have to increase their revenues per user by an enormous multiple, which clearly they have been unable to do to date.

But Facebook wants to be valued as an ad company, so let's compare them to an ad company. The New York Times reported total revenues last year of almost $3 billon. Its digital subscriber base is under 400,000 including online subscriptions to the International Herald Tribune. Add traditional, printed edition subscribers to the Times and The Boston Globe, ignore double counting, and you still end up with a subscriber base safely under 1 million. So the Times' revenue per subscriber works out to be 500 or even 600 times greater than Facebook's revenue per user. Yes, the Times has been around longer, but it is supposed to be in a dying industry. But Facebook has been around long enough to figure out how to monetize the US, and it has not done so as an ad company. Additionally, its prospects for ad revenue in emerging African and Asian markets may be limited.

So, ignore if Facebook's current business model is in the best interest of its users. Is Facebook's business model working for Facebook? Perhaps not.
  1. Indeed, can this business model work?
If Facebook is not a successful ad company yet, why not?

Can an ad-based social network business model succeed? Do we want ads during a social interaction?

Are ads appropriate in a social interaction? Did you ever try to sell a used car during your speech as best man at a wedding? Did you ever try to sell life insurance while speaking at your daughter's graduation party or your best friend's graduation party?

Are ads effective in a social interaction? We may tolerate ads on Facebook, but only because they are so easy to ignore. We may tolerate them, but do they work?

The time we really want product recommendations based on personalized information is during search. When I am searching for a hotel in Chicago I want to know where my friends have stayed and what they liked. When I am looking for a restaurant recommendation in Shanghai, I want to know where my friends like the food, the service, and the beer list. The time that information about me, my preferences, my friends, and their experiences would be most useful is during search, not social interactions.

And Google+ is tying up the market for social search. It's not just doing implementing social search, it's integrating Google+ with Google search to an extent that is truly dangerous to Facebook, Twitter, and everyone else who had hoped to use data on their users to implement their own form of social search.

And the regulatory future is still unclear. The use of customers' transaction histories by their banks and health care providers is already restricted by regulations. Facebook and Google currently operate without similar restrictions, but it is not certain that they will have quite so much freedom to use customers' information in the future. If Facebook's ad revenues really pick up, and if privacy really does appear to be dead as a result, Facebook's own success would actually increase the probability of regulation.
  1. So is Facebook worth $100,000,000?
Could Facebook be worth $100,000,000? Facebook's current ad revenues do not justify the $100 billion valuation. Facebook's future ad revenues are unlikely to increase by the multiplier needed to justify this valuation. And $100 billion is a big number for an initial valuation! But yes, the company could quite possibly be worth that much.
  • If it finds a business model based on providing value to its users
  • And if it can find a way to serve its users, rather than serving ads to its users
  • But as an ad company it will have a hard time competing with Google
  • And indeed, as an ad company that compromises its users privacy in order to sell ads, it is likely to find it's tough to compete with Google+ and tough to avoid future regulation.

My guess is that the business model is going to be based on some form of subscription fee. The fee certainly will be less than most US Facebook users already pay for internet access or cable TV. It will almost certainly be less than they pay for texting and cellphone service, even if they are simply an added line on their family's service. It would be a major policy reversal for Facebook and its founders. It would be a major shock for Facebook's user base, and would inevitably drive some of their users away. But I suspect that after the shock wore off many Facebook users would be happy to pay a monthly fee for a social network that is amusing, communicative, and safe.

So what's the $100 billion for? It's an option on Mark Zuckerberg and his 800 million Facebook friends. It's an option on whatever future monetization strategy Facebook may develop. That value may be high. It may not be unreasonable.

I have to stop now. I have Facebook notifications pending.

1 These numbers were all obtained online from the week of 3 February 2012, so that out analyses would be consistent with the early analyses of Facebook's valuation.
2 It is possible to argue that it is government's obligation to use its regulatory powers to protect individuals from actions that may harm them later, even if they have no desire to be protected. Tobacco regulation obviously falls into this category. It is not necessary to examine this debate in the article. If regulatory concerns do emerge, this may also affect Facebook's valuation, as we note later.