The $10 billion fight for Facebook

The dramatic rise and continued growth of social networking service Facebook has, as we've already discussed at IT PRO, already made it a target for several potential investors. But in the past week, it's now become clear that Microsoft has decided to ramp up its interest and get its cheque book out. The water is well and truly about to be tested.

Of course, with 24 million active users worldwide, and an increasing reputation for being the social networking site where you actually go and converse with your real friends (as opposed to the 'whose got the most' philosophy that seems to grab most MySpace users), Facebook has been the source of frenzied investment speculation all year. The fact that another three million users a month are joining (to a service that has already multiplied its member numbers by six in 2007) has helpfully added bountiful amounts of fuel to the talk.

But what's put most people off thus far actually making any kind of bid has been the price tag. Facebook creator Mark Zuckerberg has seemingly put a $10 billion (£5 billion) asking price on the service (with some reports even citing as much as $15billion), and at a point in time where a worldwide credit crunch has made the cost of borrowing large amounts of money unattractive (and borderline impossible), that's been enough to fend off a good deal of interest. Reported suitors such as News Corporation, Viacom and assorted venture capitalist investors have been quiet, and it was becoming increasingly likely that there'd be no movement until the worldwide economy had become a little more stable. A deal in 2007 simply wasn't likely to happen, at least, until Microsoft stepped in.

Appreciating that Facebook had already proved its bargaining strength by reportedly turning down a near-$2billion (£1 billion) offer from Yahoo for the business last year (when numbers were far from the level they sit at now), it is now believed to have entered talks with Microsoft for the sale of a five per cent stake. And to the surprise of many, the finances involved - Microsoft is reportedly looking to pay between $300 million (£150 million) and $500 million (£250 million) for such a small piece of the pie - would match Facebook's $10 billion valuation. This alone has sent alarm bells ringing.

Boom and bust

The key cause of concern is that this may sit at the start of another era of boom and bust for the dot com industry. If Facebook pulls this deal off, then many of its rivals are all but set to follow suit.

Granted, News Corporation has already snapped up MySpace at a price that looks like an outright bargain, given what it paid for 100 per cent of MySpace is a similar amount that Microsoft's Facebook stake would cost. But the likes of Bebo, Digg and LinkedIn, to name but a few, are other examples of services that would potentially welcome a deal. It could lead to a window of opportunity for a number of businesses to garner deals that far exceed the book value of their work, and it's inevitable that many of them have a heavy interest in how the next few weeks will pan out.

So what, then, would Microsoft be getting for its hundreds of millions of dollars? Already it has an existing deal with Facebook, inked in 2006, that sees it provide advertising services in the US market. But Microsoft would surely seek to solidify this arrangement and to make it global, while keeping its key rival Google away from the service. In short, if it could pull the deal off, it would surely shut Google out of the Facebook system altogether, and give Microsoft a clear run at arguably the biggest growth sector for online advertising.

The Google point really is a crucial one. And that's Microsoft isn't alone in its pursuit of Facebook, and the search engine giant - a thorn in Microsoft's side in an increasing number of markets - is also believed to be pursuing some kind of stake. Reports from Google HQ suggest that high-level discussions about a move for Facebook have been taking place, and this opens up a real possibility that some form of bidding war between the two companies who can actually afford to slug it out may open up. Can Google afford to be locked out of the planet's fastest-growing phenomenon? Probably not. And that's why, in spite of their already-inked deal with MySpace, they're likely to put up quite a fight themselves.

Fast, but rash?

Yet that's surely why Microsoft has acted so quickly. But, wonder some analysts, has it also acted rashly? Putting the success of Facebook into some perspective, while its user numbers, traffic and time spent on site figures are undeniably impressive (and the latter in particular is of major interest to advertisers), the balance sheet is reportedly less so. Profits for 2007 at Facebook are believed to be running around the $30 million (£15 million) mark, with turnover sitting at $150 million (£75 million). What's more, the entire American ad spend on social networking services hasn't yet cracked $1 billion (£500 million) a year, and what is being spent on such advertising is being split with MySpace (with a small slice also heading the direction of the assortment of lower profile rivals).

And this is what's concerning many: the marrying up of a $10 billion valuation to $150 million turnover simply doesn't work, no matter what business textbook you're reading. Granted, leeway has to be factored in for the undoubted potential that Facebook is sitting on top of, and revenues should rocket northwards for a good couple of years. Yet will they hit the billions, and will the profits ever match such a heady valuation figure? It's the kind of gamble that even Las Vegas veterans would surely shy away from. For the lessons of the first dot com boom are still there to be learned from: one day's hero can quickly become the next villain. And there are plenty of dot com corpses littered around to prove it.

Weakness

The thinking then extends to whether Microsoft is negotiating from a position of weakness, staggering for a firm with so much liquid capital available to spend. While it's clearly one of the few companies in the sector who could outright fund such a major deal from cash reserves, Microsoft is nonetheless nowhere to be seen in the social networking sector, and knows that if Google gains a stranglehold, then it's simply going to strengthen the position of its rival still further.

Microsoft has not yet completely ruled out continuing its pursuit of Yahoo! instead, but in terms of a logical business fit, it's the social networking juggernaut that Microsoft really needs to be riding. Only if its Facebook negotiations fail is it likely to attempt to resurrect the Yahoo! deal, and even then, some struggle to see how two companies offering reasonably complementary services would successfully gel together. In short, Facebook has to be Microsoft's number one target in the sector, simply because nothing else fits its business need in quite the same way, and nothing else is likely to allow it to grow its share of the online advertising market as dramatically. The thought of Google controlling the advertising platforms on both MySpace and Facebook is also enough alone to make umpteen board meetings happen in Redmond.

Position of strength

And so, in spite of a repressed world market, Mark Zuckerberg finds himself, as the seller, in an unrivalled position of strength. So vociferous is the fight over even a minority stake in his business likely to be between multi-billion dollar companies, that he's almost certain to come out of all this with hundreds of millions of dollars in the bank, while retaining ownership of over 90 per cent of his company. It makes the decision to turn down that earlier $2 billion offer last year a prime example of how to hold your nerve at just the right time.

Zuckerberg, though, should be wary of his users: while admittedly only likely to be a minor, incidental protest at best, inevitably a Facebook group has already popped up against the deal, populated by users who say they will walk away from the service the day that Microsoft's cheque is cashed. A minor demonstration, perhaps, but one worth keeping an eye on.

Also, the broader ramifications for the market shouldn't be ignored, and while they're unlikely to stop some form of Facebook deal going through, there's a legitimate chorus of concern that valuing such an infant business at a sky-high price has all the hallmarks of a second dot com disaster. Worryingly, given the high-profile pursuit of a growing clutch of Web 2.0 services over the past year or two, it wouldn't be clear which of the new generation businesses would be able to survive such a financial fallout.

Keeping quiet

At this stage, Google, Microsoft and Facebook are keeping mum, with no officially confirmed word that a deal is being negotiated, nor that $10 billion is the value being placed on the Facebook business.

Yet behind the sheen of public relations, it's clear that all three have sprung into action regarding a potential deal. And the irony is that at a time when raising hundreds of millions of dollars for any kind of deal is becoming troublesome, that's just what two of the biggest names in the market are seemingly queuing up to spend. It's the kind of deal where neither can afford to lose, and potentially, neither can afford to win.

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