The $50 Billion (Educated?) Guess

Over the past few days I have been involved in a fascinating discussion regarding Facebook’s $50bn valuation on a finance/economics/investing Google Group of which I am a member. Many of the ‘traditional’ econ/finance folks are shocked by the bubble-esque valuation. At the same time, the technologists in the group all remain adamant bulls.  

Valuing a company like Facebook is remarkably difficult. Unlike most companies in most industries, traditional valuation methods based upon cash flow, earnings and even revenues, at this point in time, simply do net yet capture the story of Facebook and using such methods would lead to severe mis-valuation.   

I deal with similar issues every day in my professional life investing in early stage startups where traditional valuation methods are useless. Valuing these companies is much more art, than science. At the earliest stages valuation derives from qualitative, and supplemental quantitative, assessments of risk and opportunity.

With nearly total lack of visibility with respect to the actual outcomes, early stage investments are best guess bets on teams, products and markets based upon thoughtful intellect, experience and intuition. Wherever data can be used to assist the decision making, it is absolutely used. Where market comps are applicable, they are absolutely applied. But at this stage, data is a supplemental, not primary driver of the investment decision and valuation methodology.  

As companies grow, enter markets, gain customer traction, earn cash – new data is integrated into the evolving assessment of risk and opportunity. Eventually companies mature to a point where data availability and future visibility enable the use of traditional valuations methods. 

But certain types of companies, predominately young companies found in the tech sector, don’t simply exist within established markets but rather *create* new markets and new market opportunities. For these companies that are pushing boundaries of new markets, the investment and valuation analysis in many ways revert back to one comparable to that of an early stage investor – one principally driven by intuition (intellect and experience informed) on the evolving market opportunity and the relative position of company within it.

That is not to say that data is disregarded or unimportant; data is critical – used to validate or invalidate theses, demonstrate traction and trajectory, identify product/market fit, expose risk factors, etc. – but the limits of its use are well understood.  

With respect to Facebook, valuation is nearly impossible to peg down with any reasonable degree of confidence (and attempts at calculating intrinsic value are meaningless at this point). Yet, it is possible to directionally guess at the magnitude of the opportunity. For Facebook, there are four key factors driving my directional bullish assessment:

  1. the dramatically increasing role of social as part of the fabric of the web and Facebook’s position at the focal point
  2. the development of an effective and scalable display ad eco-system facilitating massive inflow of display ad spend
  3. the emergence of the app economy and virtual exchange of goods/services/offerings
  4. the ability to extract real value from rich data. 

Facebook is both a driver and beneficiary of these mega trends.

In the not-so-distant future these mega trends will no longer be at the bleeding edge but will become axiomatic market realities. At the same time, Facebook will shift strategic focus from platform development to monetization. As market and company mature, traditional valuation methods become useful. Until then, the analysis is heavily influenced by broader macro and qualitative themes.   

Read more at The Sisquokid.

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