Facebook might just pay off for Goldman’s clients

January 7, 2011

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

NEW YORK — What are all those Goldman Sachs clients thinking? They’re snapping up Facebook shares alongside the bank in a deal that values the social network at $50 billion, or an astronomical 25 times 2010 revenue. And that’s before they pay Goldman all sorts of fees for the privilege.

Yet it is conceivable that these well-heeled investors could recoup their investment in a few years’ time — maybe even make a profit. According to new information trickling out of the near $2 billion fundraising Goldman put together this week, Facebook’s margins are astonishingly vigorous, and should strengthen. Consider the bull case for Facebook.

The website founded by Mark Zuckerberg had almost $800 million of revenue and net income of $200 million in 2009, according to the documents. Furthermore, margins are rising as sales boom. It generated $1.2 billion in revenue and $355 million of income during the first nine months of 2010. Given Internet traffic patterns, it probably had around $1.9 billion of sales and nearly $600 million of income for the year.

Big companies cannot increase revenue by more than 140 percent per annum for long. And the biggest questions surrounding Facebook’s worth lie in how it actually generates sales and consequently how valuable they are. For example, matters such as how much it generates from potentially faddish sources like social gaming or how strongly revenue growth is tied to the number of new Facebook accounts aren’t clear.

But Google’s growth rate in its early years is roughly comparable to Facebook’s today. Google’s sales more than doubled in each of the two years after 2002. Put the social network on the same trajectory, and it would have about $8 billion in revenue in 2012.

Facebook’s current net margins are around 30 percent. As the business matures, it should send a bigger chunk to the bottom line. Less investment is needed, and profits boom. It’s difficult to say how high they can go, but Chinese social networking and game company Tencent Holdings offers a comparison. Its net margins are just over 40 percent.

If Facebook could achieve this level of profitability on $8 billion of revenue in 2012, it would make $3.3 billion of net income. Put this on a price-to-earnings multiple of 20 — just a 10 percent premium to the one Google commands today — and Facebook would be worth $66 billion. That may be the answer to what prospective investors are thinking.

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