The most recent trading in the secondary market valued (unlisted) Facebook at $50 billion - more than venerable sites such as eBay or Yahoo, and within sight of Amazon's c$80 billion. Since this latest valuation is little short of fifty times Facebook's estimated 2010 revenues of $1.1 billion, it raises the question of what has to be believed about Facebook's prospects for that valuation to make sense.
A quick comparison of Facebook with its approximate peers - major consumer technology retailers, websites and especially social networks - shows a chasm between the value placed on the revenues of other companies versus pure social networks. (Revenues rather than profits are used throughout because profits at Facebook are unknown.) But the things we have to believe for a valuation of $50 billion make sense just aren't all that wild.
Let's assume for simplicity that Google's ratio of market cap to revenue represents a plausible best-case for an online market leader five years after floatation, and that Facebook can achieve a comparable margin to Google on what are fundamentally very similar activities. On that assumption, for Facebook to be worth $50 billion it must generate at least $6.5 billion revenues in 2015 or about six times what it is expected to make in 2010.
Facebook primarily generates its revenues from online display advertising. That market is worth $8.5bn annually in the US and $1.4bn in the UK (the two biggest national markets by revenues) for a total around $10bn; growth is tailing off but was still ahead of 10% in the first half of this year so the market should be worth about $15bn by 2015. Facebook's share of ad impressions in both territories is enormous, and growing: in the US it accounts for 23.1% of impressions; in the UK 31%. However social network impressions command a much lower CPM than premium inventory (on news or finance sites, for example) so Facebook delivers a CPM around $0.50-$1.00 compared to an average of $2.50 across the whole web.
Facebook cannot usefully continue to grow its share of ad impressions at the current rate but it's reasonable if not conservative to assume that by 2015 it can get its US share to the 30% it already enjoys in the UK. Facebook's glut of inventory is precisely the reason average display yields are falling, but the depth and richness of Facebook's user data offers untapped opportunities for improved ad targeting, and separately advertisers are less and less scared of their brands sitting alongside UGC. Just assume Facebook achieves the same sell-through, a relatively modest improvement in ad impression market share and over five years gets its CPM up to the current market average of $2.50.
On those assumptions Facebook is making $4.5 billion in online display ad revenues a year by 2015, or about 30% of the total market.
That's still $2 billion short of the necessary $6.5 billion target. There are two options for closing the gap. By 2015 the US/UK paid search market will be worth about $20 billion. Google pays out c25% of its ad revenues in Traffic Acquisition Costs to publisher sites in its content network so that's a $5 billion pot in 2015. With 30% of pages Facebook is well placed to take home at least $1 billion of those publisher search revenues that year. Additionally, there's the Tencent virtual goods model, in which revenues are derived from users buying accessories for their avatars. That's a model that's proved to be worth about $2 billion in revenues to Tencent in China alone, so a $50 billion Facebook valuation wouldn't be making too wild an assumption to include $1 billion of virtual goods revenues in there too.
Which takes us up to $6.5 billion revenues in 2015 and a plausible justification for a $50 billion valuation.
Lots of things can go wrong along the way. Virtual gifting is hardly a secure revenue stream for Facebook; the company has a search partnership with Microsoft that is potentially less valuable than a Google deal; and display revenue growth at this level depend on some steep CPM improvements which aren't without their challenges. By far the biggest assumption - that the margin enjoyed by one online ad market leader can be mapped to another - could prove utterly wrong for any number of reasons. Social networks also come and go - to be worth anything much at all in 2015 Facebook has to outlive MySpace and its many predecessors.
Point is, this is a thought experiment to see whether $50 billion is credible, and it turns out that the assumptions you have to make to get to a Facebook valuation of $50 billion aren't absurd. They're known factors and plausible growth curves in established markets, combined with some basic assumptions about the relationship between revenues, profits and market cap. Any of the steps is open to significant challenges, without a doubt. But that $50 billion is by no means a silly number.