Facebook's Revenues Grow, But Financial Market Expectations Growing Even Faster

Although Facebook's revenues have steadily grown every year since it was founded in 2004, its valuation has seen many more ups and downs. Uncertain about the company's future, investors and would-be investors have waffled on what they're willing to pay for the company's stock. But the company started growing revenue more quickly over the course of last year, and now valuations are climbing more than ever. Investors looking to purchase privately-traded shares of the company have been paying at share prices that imply common stock valuations at around $18 billion. This is a notable number, because it's more than the $15 billion valuation that Microsoft purchased its preferred stock at back in 2007 -- a move that was widely derided at the time. The current value of Microsoft's and other preferred shareholders' Facebook stock is higher than the new common stock valuation, we can assume at this point (note that Facebook and its investors don't discuss these numbers, because the company is privately held). Without getting into all the details, preferred stock comes with special agreements, like the ability to sell first in the event of an acquisition or public offering, or strategic relationships like what Microsoft has. See Facebook's prominent promotion of its Bing search engine in its search results page for an example of "strategic." We don't know how much common stock is being discounted from the preferred stock price -- the typical practice -- but if Microsoft and the other investors who got in at the $15 billion valuation were to sell their Facebook stock today, they'd almost certainly make a profit. Valuations are growing due to statements by the company -- it said it was "free cash flow positive" last fall -- and from third party reports discussing growing revenues. We estimated a month ago that the company made between $600 million and $700 million last year, and could make up to $1.1 billion in revenue this year. Following the article we've since confirmed that estimate range with and additional source familiar with the matter. The company's advertising growth, in particular, is looking more legitimate as both brands and a wide variety of performance advertisers have begun spending more money on it in 2009. While the company doesn't directly monetize the payments-driven business that's gotten big on its developer platform, it intends to -- somehow -- with its Credits virtual currency. Investors are excited, and this is now driving up expectations in a way that once again may be increasing expectations well above where Facebook is going to be in the foreseeable future. Here's a closer look at how Facebook's valuations have changed along with its revenues since 2004. 2004-2005 Friendster got close to buying its then-smaller rival for $10 million in its first year, according to some rumors. Facebook was just on some US college campuses then, and busy growing. 2005 saw it solidify its market more, and was valued at around $100 million by the end of the year. Aside from a few tests, its revenue streams were minimal as far as we know. 2006 The industry started getting more interested in Facebook early on in the year. The cmopany rejected a $750 million purchase offer -- one rumor said the offer was from Viacom -- and was looking to sell at $2 billion, according to a report from March of that year. But around the same time it closed a round of funding that pegged the company to be worth $550 million. Another rumor around the time suggested Yahoo wanted to make a strategic investment at this time, at the $750 million valuation. By the fall of 2006, Yahoo was reportedly looking to buy Facebook for $1 billion, and was willing to go up to $1.62 billion. Yahoo's move was partially due to what, in hindsight, was an eerily accurate model: "they projected $608 million in Facebook revenue by 2009, growing to $969 million in 2010," according to leaked documents. Facebook revenue estimates for the year ranged from $50 million (Yahoo's view) to $100 million. At this time, Facebook was bringing in most of its money from banner ads, with help from early experiments within self-serve ads targeted based on information like college network. 2007 The company had begun expanding beyond colleges by this point, and it was growing fast across all demographics. Then it launched its developer platform in May, spurring the first wave of third-party applications on the site. While the platform has been through ups and downs, it was on its first wave of hype when Microsoft invested $240 million in to Facebook at a $15 billion valuation. To many industry observers, the valuation seemed way too high. When internal revenue numbers leaked a few months later -- it made $150 million in 2007 -- the skepticism appeared vindicated. Microsoft, at this time, was helping to grow revenue by providing its own banner advertising on Facebook, splitting the money. 2008 The full force of the global economic recession hit Silicon Valley this year, driving down valuations for virtually every company. Facebook had projected it would grow revenues to between $300 million and $350 million by the end of the year. Meanwhile, some early employees were leaving the company and selling vested stock to private investors. This meant private investors were trying to price Facebook's market value -- even though it was a privately-held company that was valued based on long-term potential rather than public market metrics like current cash flow. Valuation rumors started to pop up, based on the prices that some ex-employees were selling their shares for. Reports over the summer put the common stock valuation of the company at around $4 billion. Although common stock is normally discounted versus preferred stock, the disparity made the $15 billion preferred stock valuation look even less realistic. The company ended the year with somewhere slightly less than $300 million in revenue, helped by the Microsoft deal. 2009 While rumors persisted through the first part of the year about runaway costs and low valuations, Facebook's advertising efforts appeared to have turned the corner during the same time. Today, a year ago, the company surprised most people with an announcement that it was on track to grow revenue by 70% and be cash-flow positive by 2010. Evidence also showed that the cost of servers and other major expenses needed for its growing user base were being controlled through internal technology improvements. The company also rejected additional investment at a $4 billion valuation, we heard, even some rumors at the time were putting the valuation number even lower. Then, in May, Facebook sold some preferred stock to Russian investor DST at an implied valuation of $10 billion, which clearly showed that the company's value had fallen since the Microsoft deal. A short while later, the company put its long-awaited employee stock sale price into place, allowing current employees, and then former employees, to sell a portion of what they owned to DST at a common stock valuation of $6.5 billion -- the value of this stock was on the rise. The trend continued throughout the rest of the year, boosted by Facebook's announcement in September that it had become "free cash flow positive." The main causes: fast user growth (meaning more people to look at ads) and more brand and performance advertiser spending. We projected the year to end with Facebook making more than $550 million in revenue. Instead, the Yahoo number from 2006 turned out to be even closer. Continued advertising growth pushed the company to between $600 million and $700 million, multiple sources have told us. Valuations have only risen since September. The common stock valuation implied by private Facebook stock sales was reaching between $9.5 billion and $13 billion by the end of the year, according to multiple reports. 2010 Facebook's advertising revenue appears to still be growing strong, from what we've been covering, and its valuations are climbing even higher. We estimate that the company will bring in up to $1.1 billion this year. Subsequent reports have quotes sources saying the company could reach $2 billion. Valuation numbers are correspondingly off to the races. Sites that provide private stock marketplaces, including Sharespost and SecondMarket, currently show Facebook's common stock valuation to be around $18 billion. Facebook, being a private company, does not provide details on its revenue or expenses, so analysts are now trying to project growth in the coming years based on other information, like what portion of the brand ad market it might eventually obtain. We've seen estimates about what an eventual IPO in the range of $35 billion (based on the latest filings, plus guesswork) and some see it rising to be a $100 billion company in coming years -- a number we last heard thrown around in 2007, and at the time, dismissed.

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Facebook's Revenues Grow, But Financial Market Expectations Growing Even Faster

Eric Eldon

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Eric Eldon