The Truth About Facebook’s Valuation Numbers

March 11, 2011 11:38 am

“Because a miniscule piece of Facebook got traded on SecondMarket, overall Facebook valuation at billions doesn’t make any sense”. – Is that a correct argument?

30 Billion, 40, 50 Billion, 75, then 81.5 Billion – all these numbers have been floating around as valuation numbers for Facebook. The base argument is that it’s all fine and fair, since they are based on actual auction numbers from SecondMarket.
Read this, for example:

“Last week’s SecondMarket auction for Facebook shares cleared at $28 a share versus the previous weeks $27 share price, implying a $70 billion market cap (estimated 2.5 billion shares outstanding).”

Read more: http://www.secondshares.com/category/facebook/#ixzz1GHvsbDyJ

The key word there: “implying”. So what is the issue here? So there is a ratio of shares traded to the total number of outstanding shares. The question is, at what percentage of shares traded to the total number of shares outstanding, can we actually claim that a valuation is ‘implied’ by the trade or auction ?

If we use the number of Facebook shares sold till end Jan – 3,391,265 shares, the ratio of shares traded to shares outstanding comes out to be .00135. In other words, 0.135 percentage of Facebook has been cleared through SecondMarket so far.

So here is the IPO based argument that would raise this issue: “Because a miniscule piece of Facebook got traded on SecondMarket, overall Facebook valuation at billions doesn’t make any sense”.

Let us take an example that would be closest to Facebook: Google. When Google went IPO, (ignore differences in classes of shares for a moment) – it had an auction model not very different from the current SecondMarket model, and it issued 19,605,052 shares out of a total outstanding of 271 million shares (Fun fact: Yahoo owned 8.4 Million Google shares before the IPO – almost half of what was being auctioned in the IPO)

Now let us calculate that ratio for Google – 0.0723. In other words, 7.23 percent of Google was auctioned off for the IPO.
So yes, the IPO argument holds, more or less – if the market thinks 7.23 percent of something is worth X, the whole company is probably perceived to be (100 times X) divided by 7.23.

So yes, based on Google’s IPO stats – the argument “Because a miniscule piece of Facebook got traded on SecondMarket, overall Facebook valuation at billions doesn’t make any sense” stands.

Let us forget IPOs for the time being, and look at an average trading day for Google (current market cap: 186.58B USD). Shares: 321.52M, Average trading volume: 2.82 Million. So the ratio of traded volume to outstanding shares is 0.0087.In other words, some 0.87 percent of Google shares are traded daily, and we still attribute a market cap based on the share price everyday.

So here is why we think extending the SecondMarket numbers to value the whole of Facebook valuation is a stretch:

1. The auctions have seen a miniscule part of Facebook shares
2. The market is a private market, accessible to a very select few, with a possible positive bias towards net economy
3. Tools to make negative bets (e.g. derivatives to short facebook) are not available
4. The firm is not IPOed yet to say a miniscule volume can be extended to the company’s valuation.

Thoughts?

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