Sylleptic

I’ve been wanting to write something about the value Facebook has as a business for some time, but it was this story at econsultancy’s blog that finally provoked me into action. Since Facebook sold a stake recently to a Russian investor, there’s been wild speculation and stacks of comment about how the company could possibly be worth $10 billion. The answer lies in the difference between how normal companies are valued and how Internet companies are.

Normal companies

The idea behind the valuation of a normal company is that it will be around for a long time, and will mostly make a profit most years. The sum of all those future profits turns into a value for the company. The value gets influenced by short term factors, but it’s essentially that long term profit stream that determines the value of a company. That makes tremendous sense if the company is going to be around for a long time.

Internet companies

Internet companies almost never make profits. Facebook has never made a profit, and nobody can really be confident they every will. Yet they’re worth billions, apparently. Why is that? The answer lies in who’s buying at those wild valuations. To them, the investment is great value for money, but not because of anything intrinsically valuable about the companies. Microsoft bought a stake in Facebook to underpin its own share price. Faced with criticism of their Internet strategy, their online advertising revenues, whether they really got the web, an investment of $240 million to protect their own market valuation of $50 billion plus is a very good deal. It headed off some of their biggest critics. For a while. The Russians have bought their shares because they’re portfolio risk-takers. This will be a relatively big investment for them, but one of many, and they will not expect every one of their investments to be a success. So Facebook is a bet for them, and one of many. Their plan, I assume, will be to sell their stake on to someone else at some point in the future, for a profit. If Facebook turns out to be one of those rare profitable Internet businesses, that will be easier.

The critical things about making lots of money selling your Internet business would therefore seem to be telling a good story that makes you one of the bets worth taking, or finding someone who will get some synergy from buying a stake, like Microsoft and Facebook. That’s quite a contrast from the traditional approach of growing a normal business.