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What in the Web Are They Thinking?


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In Silicon Valley, they love to say it's not about the money. Yet in late September privately held online social network Facebook, with an expected $150 million in 2007 sales, sought new investment based on a stunning $10 billion-plus valuation. A few days later, a financial opinion Web site, 24/7 Wall St., speculated that TechCrunch, a blog that grosses about $200,000 a month, might fetch $100 million or more from an acquirer such as CNET Networks (CNET). Now there's talk that RockYou!, the second-largest maker of software "widgets" that add features to social networks such as Facebook, might seek up to $500 million to sell out. No matter that RockYou denies it. Or that, by several estimates, the sum total of monthly Facebook widget advertising revenue is less than $1 million.

None of those deals has come to pass, and maybe none will. Google (GOOG) is real enough, though, and its stock price shot past 600 on Oct. 9, giving the search giant even more power to buy up companies. These lofty valuations have a lot of people in Silicon Valley and beyond squirming. They worry about a replay of the dot-com boom, which peaked early in 2000, only to crash later that year. "Companies like Facebook are driving everybody bananas," says Sumant Mandal, managing director at Clearstone Venture Partners.

But the bubble chatter misses the point. Buyouts by established companies, from Google, Microsoft (MSFT), Yahoo! (YHOO), and eBay to News Corp. (NWS) and CBS (CBS), bubbly as they may appear, serve a valid strategic purpose. Marketers and media companies alike fervently believe there are lucrative opportunities to get people engaged with their brands, products, and ads in ways Madison Avenue could never dream of.

Fantastical valuations signal an important transformation in the Web economy, one that will shake things up even more than the dot-com bust did. The Web is changing from a place where people find information, entertainment, and products over to a social medium where they share videos on YouTube and communicate with friends on Facebook.

ACQUISITION BINGE

Consider Microsoft, which was said to be interested in buying a 5% stake in Facebook for up to $500 million. That's 2% of Microsoft's $23 billion stash of cash and short-term investments--chump change for pole position on the emerging new Web. And the downside of betting too much is minimal. As if to prove the point, when eBay recently took a $1.4 billion writedown on its $2.6 billion acquisition of Internet phone service Skype in 2005, its stock actually rose slightly. Investors had already written it off themselves.

And so the race continues to heat up. In August, Microsoft closed on its $6 billion acquisition of online ad firm aQuantive. Yahoo recently bought online office productivity software maker Zimbra for $350 million and ad network BlueLithium for $300 million. Google alone has bought 11 Web outfits so far this year, about double last year's pace, including a "microblogging" service called Jaiku on Oct. 9.

Media companies are accelerating their activity, too, making News Corp.'s 2005 purchase of MySpace for $580 million look reasonable. CBS, for instance, bought a far smaller, more targeted music site called Last.fm in May for $280 million, a price that one venture capitalist says was more than five times what he expected. Notes Reid Hoffman, chairman of professional networking site LinkedIn and an angel investor in Facebook and other Web startups: "Strategy is a lot more important than cash to these companies."

GRANDIOSE EXPECTATIONS

That said, rationales for some valuations can get rather creative. Some members of the fast-growing Facebook ecosystem pin their analyses on the idea that the company could become the next Google. Lee Lorenzen, CEO of Altura Ventures, which recently launched a fund for companies building applications for Facebook, even makes the case that Facebook is worth $100 billion. He's assuming that various new kinds of ads and e-commerce will help Facebook produce $2.2 billion in profits by the end of 2008.

Not surprisingly, others are aghast at this kind of analysis. Anant K. Sundaram, a finance professor at Dartmouth College's Tuck School of Business, notes that the only way Facebook's value can get to $10 billion is by assuming much higher, sustained growth in users and revenue than the fabulously profitable Google. "I look at this valuation and go, 'This is silly,'" says Sundaram. Even if Facebook somehow fulfills these projections, he warns, "the mistake would be for the rest of the world to make decisions based on that valuation." Indeed, imagine what happens if the economy cools further, taking online advertising with it, and Google reports a quarter that misses analysts' expectations? A stock swoon might slow Google's and other companies' buying binge.

But for now, Google can still spend big, and tech and media executives feel they need to keep pace in building the new Web. In a sense, startups themselves, rather than silicon chips and disk drives, are becoming the raw materials of Silicon Valley. Each provides a small, modular piece of the end product; each gets acquired and assembled by the likes of Google and News Corp.--which, after all, are the ones that really know how to make money.

By Robert D. Hof


Reviving Keynes
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