Tagged: IPO

Forget Ebola, Twitter has caught Ipola

SickIpola is long-term debilitating disease that frequently is contracted in the financial markets during the process of launching an IPO.

Twitter has it bad, as this recent GigaOm piece highlights, and Facebook is also suffering.

Twitter is basically comprised of an idea, some geeks and some server space.  The last of these are not precious or scarce resources and the idea is basically now a sunk cost.  Not just for Twitter, but for anything that aspires to be Twitter like.

It therefore doesn’t cost much to be Twitter (or Twitterlike).  Logically speaking therefore, the revenue opportunities for Twitter, long-term, are likely to be similarly low.  The problem for Twitter (and Facebook) is not generating sufficient revenue to cover its costs, certainly not the costs of delivering the service its users want.  Its problem is generating sufficient revenue to justify its share price.

In the chase for this revenue, an Ipola sufferer turns away from its users and focuses on marketing directors.  It tries to turn itself into a media platform or a data mine, because that is the only way it can seduce the marketing dollar.  And in the process it basically destroys what it was that made it successful in the first place.  Its vital organs start to fail.

Twitter is basically a conversation.  Take the chronology out of conversation and it stops working.

Twitter is never going to be some sort of content lillypad – which has always been its problem.  It has no real estate on which advertising dollars can settle.

Which would all be fine, if it didn’t have try and keep the boys on Wall Street happy.

Ipola is not going to kill Twitter just yet, although it is going to run a sweat.  What will kill Twitter is when the market gets infected by a competitor – and users realise how easy it is to swap, because the size of your accumulated Twitter following means nothing (because they are not actually an audience), you don’t follow handles anymore, you follow or search hashtags (in real-time), and if you do want to follow someone (or have them follow you) they are still only a click away.  Doing a factory reset on your Twitter following is basically a good thing because it means you only get the ones back which were worth anything in the first place.

The only course of treatment for Twitter (and Facebook and LinkedIn) is to recognise your stock is going to become a devalued currency when Wall Street finally realises you are never going to hit the long-term revenue expectations, so use it while it is trading at such a ridiculous premium to buy other companies that can then become the lifeboats for when the business model sinks.

Why Facebook is worth only $5.6 billion

Given today is Facebook listing day I figured I had to add my pennyworth (again) to the whole “is it worth it” debate.  I reckon the true value of Facebook is something in the order of $5.6 billion.  Here is how I derive that figure.

First I take a stab at guessing what it costs to deliver A Facebook (i.e. the service that Facebook delivers to its users, rather than the service it delivers to advertisers).  I reckon this is around £300 million.  It is the costs for the server space and the techy maintenance.  Now I know Facebook states it has much higher costs than this, but these are the costs associated within maintaining a business model that it needs to sustain a valuation of $100 billion – not the costs associated with delivering the service to its users.

Then I add a respectable margin to that figure (say 25%).  That gives me revenue of $375 million.  Then put a 15x multiple on that and you get $5.6 billion.

Now, Facebook is already generating much more revenue than the $375 million I think it should be earning.  So my figures are already wrong, right?  Well go back to basic economics.  In the long-term in functioning competitive markets, companies cannot generate significantly more for providing a service than it costs to deliver that service – because that simply creates a window for a competitor to come in at a lower price.  You can only break this rule by distorting the competitive framework in which you operate.  Facebook is currently operating in a distorted market because there isn’t a competitor and all the clever analysts haven’t yet actually worked out a realistic model for valuing something like Facebook – they all rely on a derivation of the old media platfrom model, forgeting that Facebook is not a media platform and its users are not an audience.  Facebook is actually an infrastructure – an infrastructure that cannot basically charge for the majority of the cost of that infrastructure because we already pay for it through what we pay to our internet service provider.

And as for competitors, they will come.  And their competitive edge will come from promising users that they won’t sell the users’ data.  And they will be able to do this, because they won’t need to sell the data, because they won’t need the revenue, because they won’t have to sustain a silly valuation.

Therefore, if you place a bet on Facebook at its current price, you are betting on Facebook’s ability to maintain a distorted market.   Long-term this is an absurdly risky proposition.

Long exposition on the value of Facebook and Google here.

Facebook IPO valuation: its all about costs, not about revenue

I have had a quick look at the Facebook prospectus.  The thing I found really interesting was not confirmation of revenue and its dependence on advertising, but a very first glimpse of how Facebook’s costs are structured.  I  believe the key to working out a long-term, sustainable valuation for Facebook as a business lies in its costs – for the very simple and old-fashioned reason that a business cannot create marginal revenues that are significantly greater than marginal costs (if it is operating in a functioning, competitive market – which of course Facebook is not at the moment).  If you therefore want to understand long-term revenue potential, understand marginal costs.

Facebook has shown its costs thus:

  • Costs of revenue: $860 million
  • Marketing and sales: $427 million
  • Research and development: $388 million
  • General administrative:$280 million

This, of itself, is quite an intersting breakdown.  What other companies might there be where marketing, sales and R&D account for 41% of total cost?  A pharmaceuticals company perhaps?  However, what Facebook hasn’t done is split costs out in a way which allows us to see how much Facebook is spending on people, versus how much is spend on tangible operation costs, such as server space and data centres.  What Facebook labels “salaries, benefits and share-based compensation” is included within the figures for each of these categories, including the ‘Costs of Revenue’ line.  One would suspect that, in reality, people costs are a very sigificant element in all of these categories and it would be nice to know how this breaks down – not least because it will give us a glimpse of what it actually costs to deliver and maintain the infrastructure that is Facebook.

Knowing this is pretty important because it allows us to get a handle of what Facebook’s true marginal costs are and thus its true revenue potential.  What is already clear is that most of the costs associated with marketing, sales and R&D are not true costs, in that they are the costs Facebook has elected to incur in order to support the business model it has chosen to construct.  They are discretionary costs, in that any competitor coming into the market need not incur them in order to deliver a similar service to users.  In effect, Facebook has decided to incur these costs in order to service advertisers and chase sufficient revenue to justify a valuation in excess of $60 billion, rather than the revenue it needs to actually deliver the service to its users.

Look at it another way.  Facebook has 845 million active users.  Match this against costs of $1,955 million and this comes out at $2.30 per user.  Now I know this isn’t a truly accurate way of establishing marginal costs – but it probably isn’t way short of the mark.  So are we to believe that it costs Facebook around $2 to service every additional user.  Of course not, it will cost Facebook much less than this.

If I had to take a stab at it, I would reckon you could deliver A Facebook (if not The Facebook) to users for something in the region of $300 million.  Take that, plus a margin of say 25% and that gives you revenue of $375 million.  Put a multiple of say 15x on that and you get a valuation of $5.6 billion.  The fact that Facebook is already earning revenues of $1.7 billion, and carries a valuation in excess of $60 billion might give one pause for thought.  I don’t earn millions as an analysts at Goldman Sachs – so I wouldn’t necessarily set much store on my opinion.  But if I were an analyst at Goldman Sachs, I would certainly want a whole lot more information on Facebook’s costs.

LinkedIn CashedUp CrashReady

LinkedIn has ended its first day of trading as a public company with valuation of $8.9 billion.  This is 36 times its 2010 revenue.  That’s right – 36 times revenue.  As this Mashable piece points out this compares with Google at 5.5 times 2010 revenue and Demand Media at 4.4 times revenue.

What is the difference between LinkedIn and Demand Media? Well,  Demand Media has a business model: a business model that is currently working and which is rooted in the fundamentals of its business.  LinkedIn has none of these things.  Perhaps that fact that Demand Media has a functioning business model means that analysts have some form of reality upon which to base their assessments, whereas for LinkedIn all we  have is a model that appears to be a cocktail of one part fantasy and one part ignorance.

Whatever model the ever-so-clever money men are using, it will probably be one that basically regards LinkedIn as a form of content platform or media.  However, LinkedIn, Facebook et al are not forms of media, they are actually infrastructures – that is certainly is the way people use them.  I don’t know how you value LinkedIn as an infrastructure, especially when it is an infrastructure that didn’t really cost anything to build, where the idea behind it easily replicatable and the content within it essentially remains the property of its users.  That sounds to me like a max three or four times revenue multiple proposition.

At some point in it is going to dawn on Wall Street that these properties are largely disposable infrastructures that simply host content on behalf of users – basically branded data storage facilities with some service add-ons.  And then we will get the crash.