How to get valued like Facebook, $100 Bn?

January 29, 2012 1:21 am 1 comment

Recipe for Valuation

Is Facebook worth $100 Billion? was a post made by the Wall Street Journal
a few months ago which carried an interesting perspective from
Geoff Yang, Founding Partner with Redpoint Ventures, Menlo Park. Geoff gave an interesting perspective on how Facebook could be valued based on its potential market share of the Ad market and the projected growth of the market by 2015. You can read the full post here. (If you know how to get past the Pay Wall that is!)


Yesterday (1/28/2012), Lance Ulanoff of Mashable wrote another post with his
perspective on Why Facebook is worth $100 Bn?

Timing of such articles while good from a consumer/investor stand point is also an issue, given that the Facebook IPO is around the corner. Articles that justify value may skew investor perception irrespective of whether Facebook worth it or not.

Am certain that Lance or anyone else who is writing about Facebook valuations is suddenly realizing the true potential and value of what Mark Zuckerberg and crew have built. They are most likely not doing so because of calls from the Facebook PR team seeking these posts, as that would be violation of a few SEC rules in the book, one would think.

Interestingly, Lance’s suggestion of facebook’s potential may not be far from the truth.

Before we think about valuing Facebook let us just understand what it means to value any business.

Once we understand basics of business valuation then we can see whether Facebook valuation is worth it or not, also factoring that Facebook might not be just, any business.

A perspective on how companies are valued:

Companies or Businesses can be valued based on the Income they generate, Assets they hold, Brand or Goodwill they carry, Growth and Future Income Potential, Relative Comparisons to the value of other similar companies or businesses or investments (usually done based on Public or Privately published data).

Internet and Technology companies are generally valued based on, the money they are making today, by projecting it in the future to determine their full future potential.

Example 1:

Let’s say a company makes $100 mm in revenue and $25 mm in EBIDTA (profit for simplicity) then let us assume it will continue to make $25 mm for the next 10 years.

Therefore, the total EBIDTA (profit) of the firm over 10 years would be $25 mm X 10 years = $250 mm.

As this is the amount that the buyer stands to gain or the seller stands to lose once the company exchanges hands. Assuming 100% of the company is being sold.

Hence, it may be said that the value of the company is $250 mm.

This translates to: 2.5 times revenue(i.e. 2.5 X $100 mm = $250 mm) or 10 times EBIDTA (i.e. 10 X $25 mm = $250 mm). So, there are two ways to compare the value of a company one as a revenue multiple and another as an EBIDTA multiple. (For those who are wondering what happened to NPV, IRR, Payback Value etc. those are methods to value the return on a specific Project undertaken by a Company. )

Example 2

Let’s say another company was making just $2 mm in EBIDTA while had the same $100 mm of revenue.

Then its value would have been $20 mm (i.e. $2 mm X 10 years). Which would mean 10 times EBIDTA but 0.2 times revenue (i.e. 0.2 X $100 mm = $2 mm).

Hence, it may be concluded that the higher your EBIDTA the higher the chance that you get a higher revenue multiple when being valued.

There are some more factors to consider

a) Supply and Demand: Are there too many companies of your kind and hence supply is more than demand? This will almost always push the valuation down.

Say, in Example 2 above if your business was really a mid sized IT services firm based in USA and there were at least 100 other such firms out there available for sale.

Then with $2 mm of EBIDTA and $100 mm of Revenue you would likely get a valuation of just 3 to 5 times EBIDTA(i.e. 6 to 10 mm) which is 0.06 or 0.1 times revenue(0.6 X $100 mm = $6 mm).

Contrarily, if you were a unique product or service like Facebook with not many meaningful competitors around with just $100 mm of revenue and $2 mm of EBIDTA you could still get valued at $250 mm or 2.5 times revenue or even 10 times revenue at $1 Bn (10 X $100 mm = $1 Bn).

b) Discounting & Business Risk /Stickiness: Discounting is done primarly because a dollar today is worth more than a dollar tomorrow. Why?, as you can invest today’s dollar to gain interest by tomorrow.

Hence, $25 mm received over 10 years is not $25 mm X 10 = $250 mm, but less than that.

Less by how much? would depend on what interest rate you are likely to earn each year, assuming you invested your money elsewhere. Interest rates applicable for various years in the future can be taken from any yield curve(a curve of interest rates for a bond). Assuming, you as a buyer could alternatively have invested his money in bonds.

Alternatively, an Expected Rate of return could be applied (a arbitrary rate of return that you hope as a buyer to get if you invested your money elsewhere, mainly a negotiation tactic).

Now to value what the $250 mm is really worth today, you would discount is with the Interest Rate or Expected Rate of return, which usually varies anywhere between 10% to 30%.

How does one decide whether to pick 10 or 30?

The buyer would always like to keep this rate as high as possible arguing that he can get better returns elsewhere.

The seller you would want the rate to be as lower as possible so you can get maximum value.

The lower rates can be justified if the firm has stable and predictable cash flows or high stickyness to a service (lots of users who use the service everyday and whose value has not been fully realized).
Hence, the seller would argue for a lower discount rate of 10%.

What if a business does not have stickiness or stable cash flows?

If you cannot predict how much money will flow in each month or quarter in the future. For example, if you do a lot of consulting assignments and hence business always runs out at the end of the contract and you need to sell all over again to make the same amount of money.

Its like someone working for a company on an hourly wage with no guarantee of work the next week or month. These kind of businesses have higher risk so the buyer would want to discount by 30% and the seller would have little reason to ask for a lower discount rate.


All this said, the bottom line is that if you can wait it out as a buyer or seller you eventually get the best deal.

So, that is how Facebook valuation kept going up as its stock changed hands privately. Largely Income(or Future Potential Income) and a lot of negotiation.

Now, its time for IPO or Market Valuation. This means a lot more people will be judging and you don’t have them across the table from you to negotiate.

So what would you do? Hire someone to take the message out that you are worth it or give interviews yourself.

Am sure we are all aware of how the Google IPO was delayed because the founders gave an interview to Playboy and Salesforce IPO was delayed because the CEO gave an interview to the New York Times. If you wonder why? its because the SEC has ‘Quiet Period’ rules that prohibit any communication that can influence the IPO valuation. What is the SEC really trying the control by this rule? Sentiment which is driven by Conversations.

Markets are driven by Decisions made based on Sentiments which are driven by Conversations.

Valuation when privately buying or selling a business is just negotation and a game of wits and patience. While, when it comes to IPO and Market Valuation look at published (SEC filings) numbers then add sentiments to taste.

*WWoW: Watalon’s Words of Wisdom

Then again an phenomenon like Apple($1.7 Bn in 1980 at $0.12 Bn Rev and 11.7 mm in EBIDTA = 15 times revenue or 150 times EBIDTA), Google(Value $23 Bn 2004 at $3.19 Bn Rev and $0.6 Bn of EBIDTA = 7.2 times revenue or 38 times EBIDTA) or Facebook($100 Bn? 2012 at $3.2 Bn Rev and $1 Bn in EBIDTA = 31 times revenue or 100 times EBIDTA) comes along once in a Decade(10 years) or so.**

** All numbers are taken from secondary sources or are guesses and approximations based on available info, hence please factor that in when considering this information.

We will know real numbers by post IPO anyway. However, factor this > Facebook EBIDTA could be close to $1 Bn (as its being made out to be in Huffington Post). Considering they have a much higher pre-IPO EBIDTA percentage***(31%) compared to Google(18.8%) and Apple(10%), investors may value them very differently.

*** EBIDTA as a percentage of Revenues.

Also you must consider whether the value will hold, go up or come down after the IPO. All of these are possible depending on how the Earnings**** go.

**** Earnings: Income published post the IPO. Usually stock(equity) Analysts listen to and ask questions to the Company Management in a public conference call. Public or Listed Companies hold these conference calls once a quarter where the Company Management announces the Quarterly or Annual Income to the Market.

Rest is business as usual.

Leave a Reply

Other News

  • Big Data Cloud Computing Innovation Cloud Standards

    Cloud Standards

    The Cutter IT Journal August Issue carries an paper written on CARMA. The paper is a sneak preview of the content you can expect in the Cloud Standards book when it is out this winter. You can download a Free Copy of the Issue. If you missed our earlier conversations on Cloud and CARMA. I am in the process of writing my second book Cloud Standards, which is due later this year as part of the Cloud series, The Paradigm […]

    Read more →
  • Uncategorized Clearing the Cloud by Air India

    Clearing the Cloud by Air India

    This is to interested CEOs and CIOs in India who visit this Blog, you can now read about the Cloud when flying at 36,000 feet in Air India. In the past few months I have been talking to various CIOs and CEOs about the current state of the Cloud. What is most interesting to note is that despite so much buzz around the Cloud there is still very little clarity as to what the Cloud is all about and what […]

    Read more →
  • Big Data Cloud Computing Big Data Simplified – Part 3

    Big Data Simplified – Part 3

    In the 1st Part of this 3 Part Post we tried to understand the question : What is Big Data? Then in part 2 of this post we tried to understand the Issues with Data and the Evolution of Technology around Data. Now in this 3rd and final part of the Post we try to understand the Importance of Big Data and why Businesses should care about Big Data. Impact and Importance of Big Data on Business There are many […]

    Read more →
  • Big Data Cloud Computing Big Data Simplified – Part 2

    Big Data Simplified – Part 2

    In Part 1 of this 3 part post we tried to understand if not answer the question: What is Big Data? In Part 2 of this post we shall try understand the Issues around Big Data or Data more broadly. We shall also try and understand how technology has evolved around Data, Databases and what this means in the Big Data context. Issues with Data? Need for faster access to information, storage for larger and larger volumes of information and […]

    Read more →
  • Big Data Cloud Computing Big Data Simplified – Part 1

    Big Data Simplified – Part 1

    So, if you read the book (Cloud Basics – The Paradigm Shift) I had said it was really mean’t to be a Blog Post or a Series of Posts that ended up becoming a book. As, I write my first post on Big Data I can clearly see the need for a Book or maybe even a series of Books here that can help clear up the mist on Big Data. More over there is a need to clarify what […]

    Read more →
  • Cloud Computing Types of Private Clouds

    Types of Private Clouds

    Private Clouds are in the News. AT&T announced yesterday(Monday, 13th Feb 2012) its Virtual Private Cloud offering. It is interesting to see terminology evolve in the Cloud world. Am sure we have heard the terms Public Cloud, Private Cloud, Hybrid Cloud but maybe not Virtual Private Cloud. Telcos are big proponents of the Cloud. It is often argued that the Telcos stand to be the biggest gainers from the increased Internet Traffic and hence their desire to create new terms. […]

    Read more →
  • Business Finance Management How to get valued like Facebook, $100 Bn?

    How to get valued like Facebook, $100 Bn?

    Is Facebook worth $100 Billion? was a post made by the Wall Street Journal a few months ago which carried an interesting perspective from Geoff Yang, Founding Partner with Redpoint Ventures, Menlo Park. Geoff gave an interesting perspective on how Facebook could be valued based on its potential market share of the Ad market and the projected growth of the market by 2015. You can read the full post here. (If you know how to get past the Pay Wall […]

    Read more →
  • Health & Wellness Life Uncategorized Wisdom Do Blackholes exist on Earth?

    Do Blackholes exist on Earth?

    Blackholes exist right here on earth. What is a Blackhole?: Light goes in and is never reflected back to the source or sender. It is believed that this happens because Blackholes have a high amount of gravity and hence pull in anything that is thrown towards them. At least, so says the Theory of General Relativity. Then there is another theory called Quantum Mechanics that says Black holes are black bodies(no kidding) hence they must emit heat radiation like any […]

    Read more →

Please log in to vote

You need to log in to vote. If you already had an account, you may log in here

Alternatively, if you do not have an account yet you can create one here.