Why Facebook’s investors want it privately-traded

By Felix Salmon
January 6, 2011
John Abell asks a very good question about a privately-traded Facebook:

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John Abell asks a very good question about a privately-traded Facebook:

Aren’t all the people investing at this moment assuming that a $50 billion valuation is a bargain? What will drive a higher valuation — let’s limit it to the Goldman Sachs Golddiggers — that makes the investment savvy?

Can a relatively illiquid market (one open to only ultra-high net worth individuals) do that? Or are these new investors buying at what they hope will be pre-IPO bargain prices? Would they otherwise, i.e., would they put up $2 million to get a upside potential based solely on privately-reported earnings?

For the answer, it’s worth looking to Justin Fox. Yes, public markets are much more liquid and transparent than private markets. But, as accounting firm Grant Thornton says,

Generally speaking, economists and regulators have maintained that competition, and reduced transaction costs are of great benefit to consumers — but only to a point. When it comes to investments, higher front-end or transaction costs and tax structures that penalize speculative (short-term) behavior can disincent speculative behavior and incent investment (buy-and-hold) behavior that may be essential to avoiding boom-and-bust cycles and maintaining the infrastructure necessary to support a healthy investment culture. As markets become frictionless (i.e., when there is little cost to entering into a transaction), it becomes easier for massive numbers of investors to engage in speculative activity.

Goldman is requiring that investors in Facebook commit to holding their shares for an indefinite period of time: the bank does seem to be making a good-faith effort to find long-term investors rather than people looking to flip their shares the minute there’s an IPO. And for those people, the speed and efficiency of public markets, where the average stock is held for just 22 seconds, looks much more like a bug than a feature. It means that stocks become highly correlated with each other, and that the value of a stake in Facebook becomes much more a function of the performance of the stock market as a whole than it is a reflection of the value of Facebook.

Goldman’s clients are looking for uncorrelated investments, and Facebook will become much more correlated to other stocks the minute it becomes public. That’s why the clients will be happy with Facebook remaining privately-traded. After all, private markets have already bid the value of Facebook up to $50 billion: there’s no reason why they can’t bid it higher still.


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Why would the correlation go much higher when it went public?

Ultimately, shouldn’t the primary value of Facebook be in the NPV of its future advertising revenue, which is likely to be highly correlated with the business cycle whether or not the firm is public.

Illiquidity means that it is difficult to assess the value of the shares, not that they are uncorrelated with other assets.

I grant that market micro-structure combined with dynamic hedging can induce some correlation in the presence of illiquidity. That just seems easily dwarfed by inherent correlation of the cashflows of Facebook with other investment opportunities.

On these very pages you’ve pointed what a loser private equity investments have been for University endowments because they proved to be quite correlated with the general market downturn.

Posted by OneEyedMan | Report as abusive

This really makes me think of chapter 12 in Keynse’ general theory.

Posted by DrewF | Report as abusive

Can you please substantiate your claim that the average stock is held for just 22 seconds? A back-of-the-envelope calculation suggests that it is off by many orders of magnitude. MSFT has a market cap of $246 Bn, and it traded about $2.5 Bn volume today. That suggests an average holding period of around 100 days. The same calculation for GOOG gives 155 days and for AAPL gives around 90 days. (60 days may be a better figure for AAPL since it had a low-volume day today.)

For a stock to have an average holding period of 22 seconds, it would have to trade over 1000 times its market cap every day. Can you give an example of a single listed stock that does this? Or if you mean something else by “the average stock is held for just 22 seconds”, just what do you mean?

Posted by jmhl | Report as abusive

Jmhl, this is actually a questionable statistic on what it means exactly. Does it mean, the average stock “holding” ie, a purchase of 100 shares and 200 shares count the same, or is it the actual number of shares. See below link from a more accomplished financial blogger dissecting this stat and throwing cold water on it.
http://www.ritholtz.com/blog/2010/10/ave rage-stock-holding-period-11-seconds/

Crack research job again Felix, link to a link of a video of some crank promoting a book and there is no mention of a source for the stat when he says it.

you are bad at your job. If you had any intellectual integrity you would do a modicum of research on some of this stuff… but it is clearly about promoting a political agenda at this point.

Thankfully, you are beginning to lose your credibility with financial professionals when you try to stretch and post on technical matters like Abacus, where your ignorance becomes quickly apparent.

Posted by TinyOne | Report as abusive

Timing is everything.

!) Wikileaks means the heat will be off for some time. The mice will play but it seems they are skirting the rules not stomping on it. There will be bigger fish to fry.

2) Volker rules not in effect for some time, the regulators being trained about rules know less now then Goldman who has staff advising for some time now.

3) Goldman has past expertise in making vehicles that drive around regulations. they will watch their wording of risk more closely to avoid future fines for duping the sophisticates.

4) Microsoft alliance ends in 2011, Goldman in. That looks like a prop. Is Microsoft renewing?

5) Goldman gets all the holding fees. people won’t care because they will think thy have the jump on IPO which won’t be for a year and half or more. Golamn has none of the risk and all the profit regardless?

6) Goldman can’t publicly comment on IPOs and the purchase… or advertize this so a little leak later and it pretty well sold itself.

7) If in time Goldman gets another wrist slap for skirting the rules, will it have made a bundle off the suckers and give a whit they pay a fine equivalent to a few days ‘work?’

People like the shell game and are drawn to it, which is obvious. If the ‘sophisticated investors’ use their own money, fine…

here’s a good article..

http://dealbook.nytimes.com/2011/01/06/f acebook-on-track-for-i-p-o-questions-for -goldman/

This URL is for a little levity …

http://byrondennis.typepad.com/it_invest ment_research/2011/01/goldman-sachs-impo rtant-questions-about-facebook-microsoft -google.html

Posted by hsvkitty | Report as abusive

TinyOne, thank you. I always wondered where Mr Ritholz got his reputation given everything I ever read of his pure unwashed nonsense. Goes to show what happens when you extrapolate from a small sample size!!

Posted by Danny_Black | Report as abusive

Felix –

I think an actual, true, long-term investor who understands something about what it’s like to work in the environment of a small, growing corporation would agree with your point.

I doubt that more than 3 of Goldman’s clients coveting Facebook’s shares fall in that category. The rest are flippers–they just happen to be flippers with a little bit of a time horizon.

Posted by fixedincome | Report as abusive

fixedincome, facebook is hardly a small company. Also I suspect that GS is not making people hold the investment for a long time rather they are disclaiming the existence or otherwise of a liquid market – which is pure and simple boilerplate which somehow has risen to deserve a post.

Posted by Danny_Black | Report as abusive

I honestly think this has all got a lot to do with the fact that Facebook doesn’t want to disclose information like how much its advertisers pay per click or what its overheads are. It would rather let that information be rumoured and therefore blown up. The reality, I suspect, is that Facebook is having major trouble getting people to actually click their ads. Google has a totally and utterly different game, people go looking for something, and when they search, they get some ads which paid to be at the top. Awesome. When I’m on Facebook I’m not looking for anything to buy. Never. That doesn’t seem like a great formula to generate actual clicks. I bet their ad revenue per space is surprisingly low, and also that their click-through stats are horrible. In time that is going to feed through. It’s a great concept and I’m sure will remain very popular for a long time, but honestly long term nothing more than an OK business model. I might be wrong. We shall see.

Posted by drewiepe | Report as abusive

drewiepe, well apparently these are the financials.

http://www.reuters.com/article/idUSTRE70 359V20110106

I suspect a significant portion is the social games thing.

Posted by Danny_Black | Report as abusive

drewiepe, I think you are absolutely correct. Unless there is a whole new strategy that Facebook is taking, the dynamics are nothing like Google.

I know many people are on Facebook, but they are students and teens who have little money to be targets for ads and they have multiple accounts to be able to befriend themselves to look good.

There are also fake accounts to spy on exes and of course there are those who wish to remain anonymous so they can harass others. How many people have multiple accounts with fake names? Being tall you need is a unique email, how can unique users be identified? There is no way to know for sure, but you could probably cut the numbers in half and not feel badly.

Are adults using the site to Network or play games they are addicted to? Part of the reason I don’t use the site is it seems that’s what people are doing. Exchanging pictures and playing some farm game whilst allowing facebook to own any data you enter may be good for Facebook, but does that really convert to numbers for advertizers? Is having access to that data what is important and if so, how much is revealed to them? Facebook is pretty notorious about privacy issues. Facebook has proven they can give a poop about privacy. If they become public, will shareholders care?

http://www.readwriteweb.com/archives/fac ebooks_zuckerberg_says_the_age_of_privac y_is_ov.php

A little hypocrisy in that URL to note given he wants keep Facebook a private Company.

Also closing an account in not easily done. You deactivate it, so it is inaccessible to other Facebook users BUT it remains on the data base and once you log in it is reactivated. Does facebook leave deactivated accounts on the unique userlist? Likely they do. After all the profile isn’t actually closed. Closing an account takes a lot more searching and most wouldn’t be bothered. They have even made a way for the dead to be immortalized rather then close the account… that’s something you won’t find on Google.

People like me who use Facebook solely as a way to avoid registering for new accounts/passwords so I can comment are not looking at ads. I would never let my teen use his real name nor would I use mine. I have never used the site for networking. I have never seen an ad as I have several ad blockers. I wonder how many of those clicks are like me.

This is still fairly moot anyway as people aren’t looking on this as an investment but rather as a quick flip as you say, to ride the hype wave. I just closed my son’s and my accounts, but other people are so addicted to their ‘friends” I doubt they even know how they are being used in this social monetizing experiment.

Posted by hsvkitty | Report as abusive


Posted by fresnodan | Report as abusive

Another reason for this private placement shenanigans is that that they can play with “low float” stock dynamics to boost the initial valuation. Basically, it is easier to sell 1% of a company for less than $500 million than sell the whole thing for $50 billion. Look at how well VM Ware did when most of the shares were locked up in EMC and the employee required holding period. By keeping a very low float Goldman only needs a fraction of its clients to establish the $50 Bn valuation. Then, when the stake trades up to $65 Bn because the market is so thin and Goldman does the IPO at a $60 Bn valuation everyone wins.

The reason for the lockup period is to take advantage of the same loopholes that private equity and hedge funds use to avoid registering their holding companies as mutual funds and avoid registering their investments as securities.

Posted by TurtleBay | Report as abusive

Sungard went private so they would not have to worry about their customers shorting their stock, or whatever:

“The person familiar with the deal told the Mercury News that selling the company to private investors will allow SunGard to more easily implement its core strategy without the pressure of having to produce quarterly profits for Wall Street.”


Sungard provides the “plumbing” for much of Wall Street, so they ought to know.

Posted by bidrec | Report as abusive

http://www.cnn.com/2011/TECH/social.medi a/01/26/zuckerberg.fanpage.hacked.mashab le/index.html?iref=NS1

Just had to add this as one reason why Facebook is not a place you want to store your private information…

Posted by hsvkitty | Report as abusive

Oh well, it must be ok then… as he was invited! LOL

http://www.facebook.com/note.php?note_id =467531498919

Posted by hsvkitty | Report as abusive

Oh well, it must be ok then… as he was invited! LOL

http://www.facebook.com/note.php?note_id =467531498919

Posted by hsvkitty | Report as abusive

Based on the links that Danny black and hsvkitty have provided, it look’s like Facebook’s forward PE does in fact rival the 1980′s dot.com’s. How long of a shelf life do you really think that Facebook has? Selling a social network service to advertisers seems extremely vulnerable to the next best thing that comes along. Odds are that Facebook has already peaked! Goldman is a genius (or evil, depending on your perspective) at selling worthless crap (Abacus also comes to mind) to people who somehow came across huge sums of money in spite of their lack of intelligence.

Posted by xyz2055 | Report as abusive