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Summary:

Facebook today confirmed that it has received a $200 million investment from Digital Sky Technologies, valuing the Palo Alto, Calif.-based company at $10 billion, significantly less than it was in 2007 after an investment made by Microsoft valued it at $15 billion. In a conference call […]

n20531316728_2397 Facebook today confirmed that it has received a $200 million investment from Digital Sky Technologies, valuing the Palo Alto, Calif.-based company at $10 billion, significantly less than it was in 2007 after an investment made by Microsoft valued it at $15 billion. In a conference call discussing today’s news, Facebook CEO Mark Zuckerberg blamed the differences in valuation on the current economic conditions, and the fact that Microsoft was seeking a strategic relationship with the social network.

In a nutshell, DST operates or has a stake in several top social networks in Russia and Eastern Europe that actually make money. Zuckerberg said he hopes to capitalize on his new investor’s experience monetizing those social networks, but stressed that this deal isn’t about the cash. I beg to differ.

On the call Zuckerberg noted that an IPO wasn’t imminent and said this money was more of a cash cushion given that Facebook has been EBITDA positive for the past five quarters (going on six). The company expects to be cash-flow positive in 2010, he added. I’m not privy to Facebook’s financials, but using EBITDA for a business that requires a constant and continued purchase of servers is meaningless. The metric measures earnings before interest, taxes, depreciation and amortization and is often used as a substitute for cash flow. But in businesses in which equipment costs are high and replaced in a short amount of time (servers typically only last 3-5 years), EBITDA is essentially a meaningless metric.

For example in January 2008 Zuckerberg said Facebook expected EBITDA of $50 million for the year, which sounds lovely until you do the math (as Kara Swisher did) and realize that given Facebook’s plans to spend $200 million on servers in 2008, cash flow would have been negative by some $150 million. Today Zuckerberg said that Facebook expects to be cash-flow positive in 2010, which means that Facebook will continue to lose money throughout this year. And it may be losing a lot of money, given its expenses. In March, Facebook was looking for $100 million in debt for equipment, and Om Rich Miller over at Data Center Knowledge has estimated Facebook spends $20 million to $25 million a year just to house its servers.

The social network has raised more than $350 million in previous deals, as well as some debt for equipment, but an entrepreneur doesn’t dole out additional equity lightly. Zuckerberg hinted on the call that this capital might go toward a future product or acquisitions, but the deal may also reflect concerns over the ability to get debt financing in this market and the length of any recession.

Another interesting item in this funding includes a separate $100 million that DST is committing to buy out the common stock held by current and former Facebook employees — a trend we noted last year. As Zuckerberg said on the call, the company isn’t anticipating an initial public offering, and apparently insiders are getting antsy. Facebook already attempted to create a common stock repurchase program once before, but finding an acceptable valuation was too difficult, and the program was shelved. Zuckerberg offered up few details about the proposed program, saying they’d be disclosed at a later date. Because Facebook’s common stock is stripped of many of the preferences that the stock of investors like DST or Microsoft has, the valuation for the common stock will be the best indicator of the company’s true worth at that point in time.

  1. Nick Hawkins Tuesday, May 26, 2009

    $200 million seems like 6 months of operating expenses to me.

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    1. valuation man Thursday, May 28, 2009

      Server costs Vs manpower costs is the key. They can layoff to cut costs, once all developments “over”.

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  2. EBITDA positive for the past five quarters (going on six)…company expects to be cashflow positive in 2010. Huh? Sounds silly. Like you said: EBITDA is meaningless. Doesn’t Z understand this? When, quarter after quarter, you cannot get from EBITDA to cash flow positive, maybe you need to change something. Then again when you can raise $200M on $10B, why change

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    1. Of course he understands this. But admitting the truth – that they built a vast user base without an initial plan of how to monetize it – would be tantamount to admitting that he hasn’t got a clue.

      The fact is that Facebook, like most Web 2.0 “success stories”, was built without any idea of how to convert free users into paying customers other than “sell ads”. There was also a failure to understand the fundamental economics of running massive server farms, or that demand for server capacity and bandwidth grows exponentially for social networks as the number of users grow.

      With a social network, the more users you have, the more attractive it is to new users (because they’ll find people they know there), so growth in numbers can quickly spiral. The more connections people have on a network, the more likely they are to use more features on it, spend more time on it – and thus the per-user consumption of resources goes up, rather than down (unless your network fails, of course). In terms of server time and bandwidth, social networks operating almost to the opposite of economies of scale – the average user could actually cost the company more per year as the network grows.

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  3. I have disliked the FB’s management and actually FB for quite a while now. However, in the last few months I think that Zuck is actually playing his cards right.
    Let’s not forget that FB is about 5 years old and it’s valued at 10bn in the current market climate, where many well established companies are struggling.
    In the last few months valuations of 4-6bn have been rumoured so this deal is definitely a good coup for them.
    Especially as it brings not only money but also DST’s expertise.
    Also, let’s not forget that the guy is 24 and he can be forgiven if his communications are not perfect.
    The moeny is probably needed for many reasons, buffer, acquisitions, etc. and at that valuation they would be silly not to take it.
    My two cents.

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  4. Why do they spend so much money on servers? Why not go to a hosting system like http://www.tugtest.com ?

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  5. They have certainly rasied a lot of cash in the past few years, my belief is that once they really establish their ecosystem it will then be a cash cow. They have done a tremendous job so far and Zuckerberg deserves full marks for guiding it to where FB is today.

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  6. Om,

    While not many have talked about this, the big problem with Facebook’s expenses is its reliance for most part on proprietary systems, especially NETAPP devices which cost nearly 3-4 times of standard hardware. This is the same mistake that Yahoo did for its email systems until recently. Without these Netapp devices, Facebook could have been cash flow positive by now.

    Raghu

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    1. The counter to that, Raghu, is that for a Web 2.0 service Facebook has proved highly resiliant and reliable. I don’t know the details of their engineering, but clearly they’re doing something right – despite having over 200 million active users (half of whom log on every day) I can’t remember the last time they had a service outage.

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    2. Facebook just introduced a new photo storage system they call Haystack that allows them to use commodity blades instead of the NetApp gear. The FB engineering team has written about this:

      http://www.facebook.com/note.php?note_id=76191543919

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  7. Facebook’s common stock is stripped of many of the preferences that the stock of investors like DST or Microsoft has, the valuation for the common stock will be the best indicator of the company’s true worth at that point in time.

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  8. thats.. alot of money..

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  9. [...] do need to figure out how to make money sooner rather than later — unless they want to pull a Facebook and start selling off chunks of the company to finance [...]

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  10. The $100M for stock buy back may not be for keeping personnel happy. it may be instead to avoid tripping the cap on number of private shareholders the SEC says a company can have before it is forced to publicly disclose its finances.

    “A private company must report its finances once it has more than 500 common shareholders–or stock-option holders–and $10 million in assets, according to section XII(g) of the Securities and Exchange Act of 1934. That means a private company must file quarterly forms with the Securities and Exchange Commission (SEC) that disclose operating expenses, profits, partnerships, shareholders and many other details–a laborious process that can cost as much as $2 million annually.”, according to http://news.cnet.com/SEC-rule-may-nudge-Google-toward-IPO/2100-1030_3-5119504.html

    Google apparently faced this issue, too.

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