The hugely popular site seeks funding at a jumbo valuation, and Microsoft is nibbling. Yahoo and Google could be craving a piece as well
For Mark Zuckerberg, it has to be hard not to gloat. When the 23-year-old turned down Yahoo's (YHOO) $1 billion offer for his social networking Web site Facebook, some Silicon Valley veterans openly questioned his sense. Was Zuckerberg really that egotistical—or childish—to think a site where kids post photos and shoutouts was really worth a third of, say, the New York Times Co. (NYT)? But now Facebook is seeking investment that would value the company at around $10 billion—more than twice the market cap of the Times.
So far, Zuckerberg is keeping any I-told-you-sos to himself. His company refused to comment about a Sept. 24 Wall Street Journal (DJ) report that Microsoft (MSFT) is attempting to buy a 5% stake in Facebook for as much as $500 million. A person with knowledge of Facebook, however, confirmed that Facebook seeks investment at a minimum $10 billion valuation.
This is hardly Microsoft's first sign of interest. The software maker tried to buy Facebook for as much as $1.3 billion earlier this year, according to a source familiar with the matter. Microsoft already has the lock on the lucrative business of placing ads on Facebook pages. Now, with Facebook seeking funding of $50 million to $250 million and possibly more, Microsoft wants to ensure that it is the investor.
Other tech companies may want their share, too. Yahoo and Google (GOOG) could want a piece of the second-largest social network after News Corp.'s (NWS) MySpace.
Why all the fanfare over Facebook? For starters, it's popular. The company has more than 40 million users, who on average spend more than three hours a month on the site. Moreover, unlike other social networks that saw their popularity plummet after becoming mainstream, Facebook's cachet has only increased with size and age.
Such popularity guarantees marketers will want in. The company is estimated to have generated anywhere from $150 million to north of $300 million in advertising revenue so far this year. At the high end of that range, Facebook could fetch a value of as high as $11 billion in an initial share sale, says Paul Kedrosky, a partner with Ventures West and a former technology equity analyst. "It is growing quickly, which is always nice, and people spend an inordinate amount of time there," says Kedrosky. "Time plus page views creates an advertising market."
David Sze, a Facebook board observer and a partner at Facebook investor Greylock Partners, says Facebook is more profitable than leading social network MySpace, which was purchased for more than $580 million in 2005. Fox Interactive Media, the parent company of MySpace, generated a $10 million profit on $550 million in revenue during the fiscal year that closed June 30. News Corp. CEO Rupert Murdoch has said he "would be surprised" if FIM did not break $1 billion in sales this year, with $800 million coming from MySpace. Even if MySpace hits those lofty financial targets, Sze says "they would still be less profitable than Facebook."
Perhaps more important to its valuation than Facebook's current profitability and popularity is its potential for future growth. Since May, when Facebook began allowing outside software developers to create applications for use on the site, some have begun speculating that Facebook will ultimately become a kind of operating system (BusinessWeek, 7/23/07), providing users a wide range of tools, such as search, now found on computer desktops. Facebook currently has more than 4,000 "applications"—sharable software programs, or widgets, built to run on pages within another platform such as on social network profile pages. "If you think about all the dollars of effort that is going to build all those applications…that is a lot of user experience being built for the platform," says Lance Tokuda, CEO of RockYou!, a leading provider of programs for social networks, including Facebook. "That will only increase as far as we can tell."
As Tokuda sees it, all those programs built for Facebook make it more powerful, or at least more engrossing, than the average desktop that runs programs via Microsoft operating systems. Outlandish? Consider how much time people—especially the young—spend on the Web, rather than, say, reading print publications. While online, many younger people spend much of their time on social networks sharing photos, chatting with friends, and posting messages about themselves. If Facebook becomes the operating system that powers such interaction, it will "own a majority of users' time online," says Tokuda. And the company that controls the time, controls the ad dollars.
If Microsoft doesn't succeed in owning part of Facebook, the likes of Yahoo and Google would probably welcome the chance—at least in part as a way to better compete with the world's biggest maker of software. An ownership stake could potentially deny Microsoft a profitable venue for placing ads and testing its marketing muscle. It could also give Google or Yahoo a bigger share of the Web advertising market. Most threatening of all, a competitor-influenced Facebook could focus more aggressively on stealing the market for business software by encouraging developers to create ad-supported programs to run off Facebook and make the social network a more attractive destination for businesspeople. Instead of "friends," Facebook could develop special categories for business associates that include additional privacy features, for example.
Could a bidding war ensue? Microsoft was outbid by Google in the battle for ad network DoubleClick (BusinessWeek, 4/14/07). But cash-rich Microsoft is willing to pay a premium for the right deal, as evidenced by its $6 billion acquisition of ad network aQuantive (BusinessWeek, 5/18/07).
And there are some who believe Facebook is worth well north of $10 billion. Lee Lorenzen, CEO of Altura Ventures, a Monterey (Calif.) fund that invests only in Facebook applications, says Facebook could soon have 200 million users—all of whom advertisers would value highly because they can easily recommend products and services to their friends on Facebook. With so many advertiser-coveted users, Facebook could command higher advertising rates than search ads and other forms of advertising command now. "The social-operating-system idea is as big as the graphical operating system," says Lorenzen, who was involved with the latter in the early days at Digital Research, which ultimately lost out to Microsoft. "And Facebook is the first social operating system."