A couple days ago, David Heinemier Hansson of 37signals wrote a post saying that Facebook was not worth $33 Billion dollars. It was in response to numerous articles valuing the company at $33 Billion - based on the price that a few investors were willing to pay for a slice of the giant social network.
While this is certainly obvious, I feel like I need to acknowledge I'm no DHH and I'm no Joel Spolsky. Not yet anyway. :) Each of them are titans in the software world in their own right and I have enormous respect for both of them.
I find it really interesting though when people of their caliber disagree so strongly about something, and I think this is an important discussion that's missing a perspective not being taken into account. So, I'm going to jump in with my thoughts on the matter.
Heres the short story: they're both right in the short term, and Joel is in the camp of people massively speculating.
Was that $800,000 dollar house in 2006 worth $800,000? Yes, because someone was willing to pay that much for the house. But also no, because that house was valued during a credit bubble, one which couldn't last, and the smart people sold their homes knowing they were not in fact "worth" what the market was willing to bear.
DHH saying that facebook isn't worth $33B reminds me of Schiff talking in Vegas to a bunch of mortgage brokers about the coming housing crash.
I like the housing analogy for more than just the sake of bubble comparisons though. Just like a home, a business should be valued based on the following: is the money coming in greater than the interest that would have to be paid on a loan to buy said business, plus expenses? If yes, it's worth the purchase price. If not, then it's overvalued.
This simple equation is what told the smart people that the housing bubble was real and was about to blow. A $5000 mortgage on a home you could rent out for $3000/mo makes no sense. Yet, a lot of people put themselves in this exact situation.
Because they were speculating that the value of the house would continue to rise. It's the same scenario with Facebook.
Let's now use the above math to figure out whether it would make sense to buy Facebook at $33B. Let's be EXTREMELY generous and say you could get a $33B loan at 4% interest for 30 years. This would be nearly impossible by the way. Most business loans are 5 or 10 year loans - but lets stick with 30 since it'll keep us going with the housing analogy.
This would give you an annual interest payment alone of roughly $1.2 Billion, and this would be before any expenses were paid.
Unfortunately, since Facebook is a private company, no one really knows what Facebook's revenues are. Estimates vary widely from $500 million to $1 Billion for top line revenue and it's anyone's guess as to what their profit is - if they're even profitable at all.
But let's again be super, SUPER generous and say that Facebook has $1 Billion in revenue and $500 million in profit. This would give them a 100% profit margin and put their expenses also at $500 million.
So, if you were to buy Facebook at $33 Billion dollars you would have $1.7 Billion dollars in interest and expenses to tend to with revenue of $1 Billion, putting you in the red to the tune of $700 Million a year right from the start. (Another way to look at it - if you took your $33B and spread it across thousands of CDs at 3.5% interest you'd make about $1 Billion a year in interest and have zero risk.)
And again, this is under the most generous circumstances from both obtaining a loan and from guessing at Facebook's revenue. REMINDER: It's not even clear that Facebook is profitable right now. It's entirely possible that my little company has a higher profit than Facebook.
Now, is it possible that Facebook can find a way to make more money out of their users? Absolutely. I personally am fascinated by the reality that if Facebook started charging $25 per year and only kept 20% of their users they'd have revenue of $2.5 Billion and could fire everyone that's trying to figure out how to make money selling ads.
So, is Facebook "worth" $33 Billion right now? Sure, the market seems to be indicating that price right now for a piece of the company, but only because of massive speculation. But, it seems like one hell of a lousy investment without a significant overhaul of their revenue model.
(Side note: Spolsky inexplicably claims that Chicago is a "city with no other internet industry" apparently forgetting about Groupon, Orbitz, and a host of others. Now might be a good time to remind Joel that the speculative mania that nearly brought down the entire US economy was born in New York.)