How Forbes Magazine Misinformed Its Readers About Facebook And Cost Them A Fortune

On December 31, 2009 Steven Bertoni of Forbes wrote an article entitled “How Much is Facebook Worth“, where he said “firms are pooling clients’ money to buy privately held Facebook shares — and probably overpaying.”  At the time of this article, the implied valuation of Facebook was around $11 billion according to SecondMarket and SharesPost, which stated that the Facebook stock was trading at $25 per share.

If you are an accredited investor and were a reader of this Forbes article one year ago, this advice, from one of the most credible sources on stock market analysis, may have cost you a lot of money.  However, if you were a reader of SecondShares $50 billion valuation of Facebook just a few months later, you may have been able to save face.

Keep in mind, Forbes Magazine describes itself on its website as “Business News, Financial News, Stock Market Analysis – online source for the latest business and financial news and analysis. Covering personal finance, lifestyle, technology and stock markets”.  It doesn’t state that they cover “secondary private company stocks”.  I feel its a bit irresponsible for a brand like Forbes to tell their readers that investors are “probably overpaying” for a stock, without providing any real research or market analysis to support that opinion.

In the article Bertoni went on to say, “of course trying to value Facebook is as difficult as hiding from your former high school sweetheart online“.  First, I’m not quite sure Bertoni actually tried to value Facebook with any real market research or analysis, other than according to him, extrapolating its value “for fun” with the same multiple that Google had in its 2004 public offering, which was 15.7, to Facebook’s then estimated revenues of $300 to $500 million.  Second, considering Facebook is where your high school sweetheart would likely find you online, shouldn’t that have been one of the indicators to Bertoni that perhaps he’s not qualified to understand the value of Facebook.  ;-)  Okay, he left that one open.

But seriously, Bertoni’s skepticism continued with, “despite the big run-up (in stock price) in six months, little has changed about the business of Facebook“.   Sigh.  He even cited Facebook’s 350 million membership count, as well as their revenues of $300 to $500 million.  Yet, he felt their business had little change?  Really?

Well, its been twelve months since the Forbes article begged the question, “How Much Is Facebook Worth?”, so let’s take at Facebook’s continued trajectory to see if its overpriced today, “for fun”.

Facebook has gone through a 5 to 1 stock split and its stock is currently trading on the secondary market, among sophisticated accredited investors, at an implied valuation of around $50 billion.  They now have over 500 million members, or they’ve gained nearly another 200 million members in the last year.   Their estimated revenue for 2010 is now $1.2 billion, and they are at the earliest stages of deploying their monetization strategies.  In fact, according to VentureBeat, Facebook is about to get very serious about its revenue.  Facebook just leased two floors on Madison Avenue, with the potential to expand up to 150,000 square feet or 600 people, nearly all of which would likely be in sales.

Fifty percent of their 500 million members logon to Facebook every day, and they spend over 700 billion minutes per month on Facebook. The average member has 130 friends, connected to 80 community pages, groups and events and creates 90 pieces of content per month, which in total is more than 30 billion pieces of content (web links, news stories, blog posts, notes, photo albums, etc.) shared every month on Facebook.  Additionally, there are more than one million developers and entrepreneurs running a business on Facebook from over 180 countries, which over 70% of Facebook users interact with every month.  In fact, companies such as Zynga, RockYou, Slide and more have built sustainable businesses that have created billions of dollars in shareholder value on top of Facebook’s platform, just as companies such as Intuit (INTU) and Adobe (ADBE) have created billions of dollars in shareholder value on top of Microsoft’s platform.  Its no wonder Microsoft was the first to fully understand the future value of Facebook when it invested $240 million in Facebook at a $15 billion valuation or 1.6% of the company.

I will slightly agree with Bertoni regarding his supply and demand argument (that Facebook shares are for sale, and everyone wants Facebook bragging rights), but that doesn’t necessarily mean that the investors are overpaying for their Facebook shares in the secondary markets.  Remember, the secondary markets are illiquid, they’re not for traders, they’re for investors, like Microsoft’s investment.  So the question isn’t whether or not your share price is ‘exactly’ where you’d like it to be today, its whether or not you believe it will be worth more in the future, and with Facebook’s growth trajectory, vision and track record, I think we know the answer to that.

The question I’d really like to know is whether Forbes believes Facebook’s stock is overpriced today.

Jay Gould maintains a long position in shares of Facebook (private).

The Birthing of a Market

Writing about the social media revolution is so exciting because its changing the world, and that change is happening at a remarkably fast pace.  Another sea change occurring right before our eyes is the emergence of a secondary market for the shares in the companies driving the revolution.  Like Michael Milken at Drexel helped the junk bond market emerge as a rapidly scaling asset class, so to are companies like Second Market and Sharespost helping to lead the liquidity charge in the market for privately held shares. SecondShares is pleased about the role we’re playing in the ecosystem by writing research on social media companies  because thoughtful and readily available information  is another piece of the puzzle needed to increase liquidity.  It’s easy to highlight the pace at which this market is growing by simply looking at the growth in SecondMarket’s transaction volume this year (in millions of dollars):

That growth is beyond impressive, and it should warm the heart of every employee, Founder and VC that holds shares in meaningful private companies because there is an emerging third option to monetizing their shares.   Where once monetization largely occurred through IPOs and acquisitions, increasingly, shareholders can sell their shares in the emerging market for private shares.   In addition to total volume, Second Market releases data on the volume of transaction by company.  Not surprisingly, Facebook is the dominant volume leader, averaging 42% of the market the last 3 month (scale .6 =60%).

Such heavy concentration is emblematic of the embryonic stage of development of this market.   NYSE daily volume leaders  generally comprise around 2% of total market volume on a given day.

What SecondMarket doesn’t release much information on is the buyers or sellers.  That said, we do have a sense that the increase in sellers is being driven by the participation of VC’s, who are increasingly seeing the secondary market as a liquidity option.  It turns out, that while the IPO market kind of shut, and the acquisition market slowed, the limited partners of the VC’s still want to get cash returns, and the secondary market is enabling that.  As far as the buyers, while second fund pioneers like Industry Ventures remain important players, new buyers are entering the market, including both institutions and individuals (who have to be accredited investors).  If you’re playing in this ecosystem let us know.

As the secondary market grows and liquidity increases, volumes will not only increase exponentially, but volume share will dissipate dramatically.  By the end of 2010, we believe volumes will surpass $200mm per month and Facebook will have less than 10% of volume share.  While $200 million in a month kind of sounds like a lot, Google trades that much volume every 40 minutes of every hour of every trading day.  Point being, buckle your seat belt, its going to be quite a ride for anybody playing in this marketplace.

Facebook Stock Rises $4.5B In One Month On Secondary Market

Last Wednesday I wrote about some inconsistencies that I saw on ShareharesPost surrounding the LinkedIn valuation.  In that post I had mentioned their current valuation of Facebook at $11.96B, up from their June 2009 $4-6B valuation. Today in an email newsletter, SharesPost provided a new Facebook valuation of $13.41B.  That’s an amazing jump in valuation in just under a week.

However, over the last month we have heard of large transaction blocks of Facebook stock in the mid $40 share price.  When we published our research report valuing Facebook at $50B, the stock was trading between $34 and $38 per share, which gave Facebook a valuation of about $19B.

In today’s SharesPost email newsletter, there is a current bid to purchase 45,000 Facebook shares at $47.00 per share, which would put the current Facebook valuation about $23.5B on the secondary market.  That’s a $4.5B increase in valuation since our research report last month.

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.