Buyer Beware: SharesPost Index Under Values LinkedIn By Billions

Earlier this month SharesPost announced SharesPost Index, the industry’s first value index for venture backed companies.  After watching their valuations over the last few weeks, I’m a little concerned.

In June 2009, TechCrunch wrote that SharesPost reported LinkedIn’s valuation at $1.4 billion, which was $400MM above LinkedIn’s July 2008 $1 billion valuation from their $53MM round they had raised from Bain Capital Ventures, Sequoia Capital, Greylock Partners and Bessemer Ventures.  Below is a video taken shortly after the $53MM round, interviewing the investors that participated in that round with their justifications for the $1 billion LinkedIn valuation.

What I find odd is that SharesPost pegs a current valuation of LinkedIn at practically the same valuation that they had nearly 10 months ago.  In the same June 2009 report by SharesPost, they put a valuation of $4-6 billion on Facebook, and today, SharesPost reports Facebook’s valuation at $11.96 billion.  At least they agree that Facebook has created shareholder value in the last 24 months, that’s hard to dispute.

To be fair, SharesPost’s valuations are weighted and based on four inputs, which are transactions, research, financing and post inputs on their exchange.  But that’s the premise of this post, I’m not certain their weighted system is working properly for determining accurate valuations to potential buyers on their secondary market exchange.  Their website explains the weighting system as:

The SharesPost Venture-Backed Private Company Index is a modified market capitalization weighted index—the maximum percentage value of the index any company represents is 25%. The index value inputs for each company are an average of the four data inputs broken out above. Where data is unavailable or out of date (i.e., more than 120 days old), that input is omitted from the calculation and only the remaining inputs are used. So for example, where a company has not recently closed a venture financing, only the recent transactions, current posts and research report estimates are used as inputs into the SharesPost Index Value formula. SharesPost updates the Index Values on a weekly basis.

Their research valuation for Facebook is only $5.7 billion, whereas we recently reported a $50 billion valuation on Facebook.  I’m not quite sure how they determined their $5.7 billion valuation on Facebook when recent private transactions have been above $17 billion.

According to SharesPost, they do not use data that is over 120 days old (which is why the transactions and/or financing input is missing for several companies on their Index.).  The “post input” appears to be based on the recent posts on their secondary exchange, which is clearly not indicative of the overall market, although it seems close.

While in theory a Secondary Market Index seems like a great idea to help buyers on the secondary market understand what they’re buying, but providing incomplete and insufficient data when determining valuations is unprofessional at best, and potentially very dangerous to these potential buyers on their exchange.

SharesPost does list a disclaimer on their website about the valuations within their Index (see below), but I would think that they would want to ensure the most accurate valuations to help create investor confidence in their services.

The SharesPost Venture-Backed Index and the individual Index Values are only a reference point and should neither be construed or relied upon as an estimate of valuation of any company or group of companies nor as investment advice.

That said, we disagree with the SharesPost LinkedIn valuation and will be publishing a full report and valuation on LinkedIn very soon.  But I think its safe to say that LinkedIn has created shareholder value since their $1 billion round in 2008, in fact the SharesPost valuation is off by billions of dollars… if they’ve undervalued a company by billions, could they overvalue companies by billions in the future?  Buyer beware.

Microsoft Buying Facebook For $50B??

After parsing a speech by Microsoft CEO Steve Ballmer, and deciphering other tea leaves, Facebook focused blog AllFacebook.com speculated in a post yesterday that Microsoft was preparing a $50 billion bid for Facebook.  While I personally believe it would be a strategically brilliant move, I think the stock market would puke all over it, as there is little Wall Street appreciation for the game changing impact that Facebook is having across the media and technology landscape.  With Microsoft trading at less than 16.5X trailing earnings, and Facebook poised to generate just several hundred million in profit in 2011, a Facebook acquisition would be so dilutive to Microsoft’s earnings, that it is unfathomable that any CEO would take the near term impact to reputation and share price to execute on such a dilutive transaction, regardless of how visionary it could be perceived in the long run.

Facebook $50 Billion Valuation

EDITORS NOTE:  THIS POST WAS ORIGINALLY POSTED ON 2/28/10 ON THE RESEARCH SITE, TRACK.COM.

Current trading price in private market: $38      Target price:     $100

Overview:

  • Facebook is the most powerful website the world has known : With over 400 million reported users spending an average of 55 minutes per day on its site, Facebook is the most ubiquitous and transformative media company on the planet poised to create tremendous shareholder value as it begins to monetize its vast audience. Facebook already has ¾ the reach of Google and three times the average time spend per user, yielding Facebook double Google’s aggregate global time spent; and Facebook is on a dramatically steeper growth curve, growing its reach by 150%+ in 2009 vs. 40% growth for Google.
  • Facebook already drives more traffic to the leading portals than Google: While Google has long been the major driver of traffic to the majority of websites in the world, “friendcasting” on Facebook (when a friend uploads a link to content and someone clicks on it) is already a larger driver of traffic to sites like Yahoo and MSN than Google, according to Compete.com. If Facebook successfully leverages its new relationship with Microsoft’s Bing, implements more social search tools, grows its fan pages, and enables the continued natural growth of “friendcasting”, Facebook should surpass Google as the largest driver of traffic globally later this year.
  • Facebook is tracking to be a $100B company: Google has demonstrated how to monetize the time and data users give to the site daily. Facebook’s potential to monetize both time spent and data shared may be even greater than Google as it generates more time and significantly greater data on its users. Facebook also benefits from a network effect that doesn’t exist at Google. Each incremental user adds geometric value to the network. As Facebook achieves its goal of building the dominant global networked communications platform, it will begin to leverage its reach and earn its share of global advertising, ecommerce and payment revenues, possibly rivaling Google’s earnings potential. We estimate that Facebook will be worth more than $100 billion by 2015 using the same multiples on Facebook’s forecast 2015 EBITDA as Google is valued at today. More aggressive (but still reasonable) multiples and growth rates would yield values rivaling Google’s market cap of $140+ billion, ex cash.
  • Facebook is worth $50B today: If Facebook is worth $100 billion in 2015, discounting that valuation back to today with a 15% discount rate, gives the company a current value of ~$50 billion. Regardless of the discount rate you use, Facebook offers a very compelling investment opportunity at current prices.
  • Facebook is privately traded at 60%+ discount to its current value: Most investors don’t know you can buy Facebook shares today, pre-IPO. While the market for Facebook shares is not robust, there were millions of shares traded last year through private marketplace websites like Second Market.com, SharePost.com and others. Only accredited investors are allowed to participate. Currently, ask prices are about $38/share, implying a market cap for Facebook of ~$19 billion. Relative to the $50 billion fair market value we see in the company, this represents a 60%+ liquidity discount.
  • Facebook only has to earn $7 per user in EBITDA to justify our valuation: Dividing our $50B target by Google’s current trading multiple of 18X EBITDA implies that Facebook currently has earnings power of $2.8B in EBITDA. Dividing the $2.8B by the current base of 400 million users implies $7 of EBITDA per Facebook user. Facebook will have far more than 400 million users in 2015, so this is a conservative estimate. Even at $7/user, our projection is that Facebook would earn significantly less per user than other major internet companies. Amazon earns $15/user; Google earns $20/user; and eBay earns $34/user. While each of these companies operates with different business models, they all rely on aggregating huge volumes of users to create value for their investors. Facebook will earn ad revenue like Google, commissions on transactions like Amazon and eBay, and fees on payment processing like eBay. In presenting this metric we are demonstrating that even if Facebook’s earnings power is significantly less per user than other major internet players, it would still command a $100B market cap.

Quick Facts (according to Facebook , Alexa.com and Compete.com):

  • #2 website globally in total page views behind Google; should pass Google in first half of 2010.
  • At 30%, Facebook has the same global reach that Google had 1 year ago.
  • Both Google and Facebook should have global reach of ~50% by end of 2010.
  • 2 years ago Facebook’s global reach was just 6%.
  • Internet users spend 3x as much time on a Facebook page as they spend on a Google page.
  • Over 700mm pieces of content are uploaded on Facebook daily (eg. 100mm photos daily).
  • Average user spends 55 minutes/day (~23% of total time online) on Facebook, 50% of users log on daily.
  • 67% of US online users are on Facebook.
  • ~70% of Facebook users live outside the US.
  • Among top 36 countries: Facebook’s page view rank is #1 in 4 countries; #2 in 23 countries; #3 in 9 countries.
  • Facebook just received approval for patenting its news feed, the core functionality of its website.

Investment Thesis:

Facebook is already the world’s dominant website

  • However you measure it, Facebook’s global scale and growth are astounding. Of its reported 400+ million users, ~120 million are in the US. That’s 120 million out of ~180 million US internet users (according to Commscore); indicating that about two-thirds of all US internet users are now on Facebook. Facebook says the average user is on Facebook 55 minutes per day, out of a total average of four hours per day of total internet usage by the average US internet user. Those statistics are consistent with recent research based on Compete.com statistics indicating that Facebook now accounts for 25% of total US internet page views and 15% of page views in the UK. As a result of its dramatic surge in uniques and page views, Facebook is now directing more traffic to major portals like Yahoo and MSN than Google through “friendcasting” – the name given to the process of clicking on a link your friends post in their Facebook newsfeed. In this report we want to discuss two implications of Facebook’s dramatic growth.

Facebook has blown by MySpace in social networking and is poised to pass Google in 2010 in directed traffic

  • The world of television presented us with about 10 channels in the 70’s, which grew to 500 channels as digital proliferated in the late 90’s. The internet now brings us hundreds of millions of channels (i.e. websites, Facebook profile pages, blogs, etc.), which we have only been able to navigate with search. Yahoo dominated search in the early days, but they were passed by Google when Google came up with a better algorithm presented in a simpler design. Because they are the dominant search engine, Google emerged in the early part of the last decade as the dominant source of traffic for most sites.
  • MySpace was the early dominant “social network”, but the users weren’t really networked. We had to surf MySpace or hope someone came to our MySpace page to get any real value, and significant technical improvements were glacial.
  • Facebook’s improvements were simple but monumental. They used basic newsfeed technology to enable us to know what our friends are doing, thinking, buying, playing, or posting, simply by going to our own newsfeed. They also opened up their platform to third party developers, who quickly provided the Facebook community with a wide array of incredibly popular applications like Farmville, which has over 80 million players. In fact, Facebook states that there are more then 250 applications that have more then 1 million active users. While many of us used to go to Google to find the latest news, or would surf major or minor news sites to see what was going on in our world, our news and information is increasingly brought to us by friends who post news of interest to them or about them, which appears in our newsfeed. Friendcasting on Facebook will be complimented by Facebook’s increasingly deep integration of Bing’s search tools on Facebook, as well as by other social search applications on Facebook that let us mine the behavior and opinions of our friends. We believe Facebook will pass Google in terms of traffic generation to other websites in 2010.
  • Because we tell Facebook so much about ourselves, and because we spend so much time on Facebook, Facebook knows dramatically more about us than any other website in history, and Facebook’s willingness to share this data makes them an incredibly attractive partner to websites who like user data (which is almost every website). The question now is: how will Facebook leverage its powerful position to generate revenue and profits for their shareholders?

Facebook will be worth over $100 billion

  • Facebook will generate revenue from advertising, both display ads and through increasingly integrated search tools. Microsoft’s Bing, as the search provider on Facebook worldwide, compliments Facebook’s powerful “friendcasting”. Rather than merely offering links, the Bing integration will present more of the features available on the search engine itself. For display advertising, Facebook will increasingly be presenting ad formats that feature social actions. Social integrated ads perform better and provide a better user experience since they are consistent with the context and feel of Facebook. Facebook ads will also be increasingly targeted to people based on the information they provide Facebook. This combination of targeting and social relevance will drive enhanced performance and rates for Facebook display ads.
  • Global internet advertising is poised to grow to $96 billion in 2015 (according to Magna), a 10.5% five year CAGR. Traditionally in media, companies with scale are able to grab outsize share of ad spend. Therefore, as Facebook has the most global scale, its safe to assume that Facebook will attract its fair share of the market. While Facebook is still growing rapidly, we assume in our valuation thesis that they account for only 15% of total internet traffic in 2015. According to Drake Direct, based on Compete.com data, Facebook is already at 15% in the UK, and they are at ~25% in the US. We believe 15% is a conservative view of Facebook’s page view and time spend share in 2015, given its current trajectory. We estimate that Facebook’s 15% share of the global internet audience yields them a 15% share of the global internet advertising market, yielding a forecast of $14.5 billion in advertising revenue in 2015. Today this may seem like an aggressive assumption based on the fact that Facebook currently does not command a comparable CPM to many other websites for their display ads. But Facebook has just really begun to monetize their traffic and weave in targeting and social relevance, and they haven’t even begun monetizing social search. Where Google offers advertisers strong targeting for purchase intent, Facebook is the holy grail of targeted brand advertising, and is posed to make significant headway in search.
  • Facebook Connect is another powerful platform for Facebook to leverage and eventually monetize its user data. Facebook Connect is quickly becoming a de facto registration platform on the net. Currently, over 80,000 sites have already implemented Facebook Connect, including many large sites like CNN. Facebook Connect is emerging as the internet “passport” that enables people to enter any website, as well as interact with their friends who are also on that website. This will likely become another significant revenue platform, as Facebook could potentially harness Facebook Connect to create a leading ad network, leveraging their deep relationships with advertisers and their mountains of user data. For purposes of this analysis, we’ll assume they derive zero revenue from Facebook Connect in 2015. Therefore, in our analysis, investors are getting a free call on this massive business opportunity.
  • Next up, and just as interesting, is Facebook’s recently introduced payment system. Initial testing on Facebook indicates Facebook consumers prefer Facebook’s system to the other payment systems available on Facebook. Facebook is charging a whopping 30% fee to the publishers selling virtual goods (similar to Apple’s 30% take on applications sold on its iPhone platform). The system includes many other benefits for publishers (e.g. preferred placement in the gaming directory, better advertising rates) that only Facebook can provide. Analysts estimate that Facebook’s payment system will grab more then 50% share of payments on Facebook and generate $200 million this year based on projected sales well north of $1 billion in virtual goods in 2010. But payments on Facebook will be just the beginning for the payment system. Facebook Payments is well positioned to take meaningful share from PayPal all over the internet as users will increasingly be using Facebook Connect on ecommerce sites around the net. Paypal is expected to generate $3.3 billion in revenue on a base of 88mm active accounts in 2010. We believe Facebook Payments could grow to a $2 billion dollar business by 2015.
  • Given the simple analysis above, we project Facebook will drive $16.5 billion in revenue in 2015. While this is a big number, it is just over 1/3 of what Google would be projected to generate in 2015 if Google grew revenue at a 12% CAGR (about ½ it’s recent revenue CAGR of 20%). For ease, we assume Facebook achieves the same 35% EBITDA margin as Google is currently experiencing. Let’s similarly assume that Facebook, as a public company, would be valued using the same EBITDA multiple as Google is valued at today, which is 18X 2009 EBITDA. The math above implies a value of $103 billion based on 2015 projections.

Facebook is worth $50 billion today

  • If we discount $103 billion back by 15% per year, we get a price target of $51 billion today. This implies a value that is more than two-and-a-half times the $19 billion value Facebook shares are currently trading at on secondary private marketplaces. The table below looks at how our valuation would vary depending on various multiples and discount rates. Even at a 21% discount rate, Facebook would be worth more than 2x the current share price.

  • Another way to value Facebook helps put our target in to perspective. Based on current membership levels, we are valuing Facebook at $125 a member. If Facebook were valued on an 18X multiple of EBITDA today, that implies that Facebook has the power to generate $7 in EBITDA on average off its members, or $20 on average per member in revenue (assuming 35% margins). Neither number appears a stretch. Amazon earns $15/user in EBITDA, Google currently earns $20/user, and EBAY earns $34/user. We recognize these companies all have different business models, but we think it is helpful to put some context around our $7 EBITDA per Facebook user projection.
  • Is a 15% discount rate too low given that we’ve seen other social networks appear and then fade, most recently MySpace? We’ve seen other internet leaders founder – is Facebook like Yahoo? Is it possible Facebook is just a fad, as some argue? Our thesis is that Facebook is already deeply ingrained in our daily lives, and this is just the beginning. There are many reasons why the switching costs are significant, and Facebook keeps adding new ones – most recently Facebook was granted a patent on “the feed”, a core feature of Facebook’s functionality. Facebook is averaging over 100 million photos uploaded per day. People don’t like to leave those behind. With an average of 130 friends per user, almost everyone has many connections that only exist on Facebook. The average person is a member of 13 groups. As we increasingly move to mobile, we are bringing Facebook with us. The Facebook iPhone app has been downloaded by over 28 million people. In addition, every wireless operator is advertising the availability of Facebook apps on their phones.
  • Maybe our estimates are too conservative? 15% share of online ad revenue and 35% operating margins could prove too low. The data table below shows that each 1 percentage point of share of the online ad market for Facebook is worth $3 billion present value at a 35% margin. With 30% reach of global internet usage today, it is conceivable that Facebook ad share could be well over 15%.

Facebook shares are available for accredited investors to buy and sell, and the current value is $19 billion

  • There is a secondary private market for Facebook shares on sites like Sharepost.com and SecondMarket.com that make markets in shares of dozens of private firms, enabling employees to monetize some of their options.
  • After proving you’re an accredited investor, the transaction is papered, with the seller paying transaction costs.
  • While Facebook enables employees to sell their shares, the buyers of these common shares are prohibited from subsequently trading their shares until Facebook goes public or is acquired.
  • Right now, shares are being offered at $36-$38 per share, implying a market cap of $19 billion.

Catalysts:

  • With only $600 million in rumored revenue in 2009, Facebook has done little to monetize its vast reach. As Facebook revenue generating initiatives start to scale, private market values should increase.
  • When the company goes public, the liquidity discount will evaporate and prices will rise to fair value.

Risks:

  • Shares bought in the secondary private market are not liquid and do not entitle the owner to the information usually provided by public companies to their investors.
  • Another competitor could arise and take market share from Facebook. In fact, to the degree that Facebook attracts 15%+ of all internet time, every other website on average is generating 15% less traffic. So it’s easy to imagine other sites working together to try and thwart Facebook. But like Google, other websites will increasingly see Facebook as a “frenemy”, a strong competitor for the mindshare of internet users but also a driver of massive traffic.
  • Facebook either may not be capable of or may not be concerned with generating massive revenue or going public. This is unlikely since history has shown that once eyeballs are assembled, advertising and other monetization opportunities present themselves. Some people thought no one would advertise on MySpace, and they were proven wrong. And Facebook is far more advertising friendly than MySpace as pages are much less free form. While a few companies (most notably CraigsList) appear uninterested in maximizing revenue, Facebook’s significant VC investors will help drive both monetization and an eventual liquidity event. In addition, like Google, Facebook will need to generate cash to help finance its increasing spend on R&D to drive innovation.
  • Privacy remains a significant concern of internet users globally, and with all the data Facebook aggregates and make available, they are walking a fine line. Facebook has clearly had some missteps in the past, most notably its Beacon information sharing product in 2007 that caused an outcry from privacy groups. They have also had technical glitches, one as recent as last week where messages were misrouted. As a result of these lapses, Facebook is acutely aware of the privacy issue and they appear to be thoughtful in their approach. Google also struggles with privacy, as evidenced by their recent bungling of the introduction of Google Buzz.
  • Given Facebook’s increasing stranglehold on internet usage, governments in the U.S. and elsewhere could step in and, in some way, break up the near natural monopoly on social networking that Facebook will have. Google is already starting to face serious antitrust issues in Europe.