Goldman Sachs, Facebook, the SEC and Bubble 2.0

Ah me - I thought it was 2011, but it looks like I have woken up in 2001. Today we learn of a bit of Goldman Sachs financial jiggery-pokery investing in Facebook - Bloomberg:

Goldman Sachs invested $450 million in Facebook and is planning to create a special purpose vehicle for its clients to make additional investments worth as much as $1.5 billion, according to two people familiar with the matter who spoke on condition of anonymity because the deal is private. Some private companies avoid crossing the disclosure threshold when investors’ funds are channeled through a single entity, such as a private equity firm or hedge fund.

“The real question is, what are the details of this special purpose vehicle?” said James Angel, a finance professor at Georgetown University’s business school in Washington. If the investment is designed to circumvent the rule, “the SEC should be looking very closely at it.”

It gets worse (or more amusing, if you have that turn of mind - history is first a tragedy, then a farce after all) - this investment is $500m overall for 1% of the shares, which values Facebook at $50 billion. I understand 2010 revenues are about $2 billion (well that's what Facebook say, but you can't check it* ), that is 25x revenues for a company that already has c 500m customers. You can believe one of two things - either, as Don Dodge does, that all valuable assets look expensive at the time:

The best properties always look too expensive. Market leaders command the highest prices. It is only a year or two later that they look like great deals. The experts thought Microsoft was crazy when they invested $240M in Facebook at a $15B valuation. Crazy like a fox. Digital Sky Technologies invested $200M in Facebook in May of 2010 at a $10B valuation. The "experts" thought the Russians had gone crazy. What do they think now? Just 7 months later Goldman Sachs is investing $500M at a $50B valuation. No one ever called Goldman Sachs crazy.

Or you can look at the economics and note that Goldmans is buying under 1% of an illiquid stock, thus valuing the whole 100% at $50bn, and that to justify such a valuation at maturity (at say c 5x revenue valuation, like Google) would imply revenues of $10billion. Given that it already claims c 500m users (1/8th of the world's online population, because as we know, there are no false accounts on Facebook) it is hard to believe much more than a doubling of users, so say 1 billion users. So, $10 bn over 1 bn users is $10 per user per annum (vs c $4 today), or say $1 / month. Sounds possible, except you have to remember that many users hardly use the system, and social media ads tend to have CPM in the fractions of pennies, so you are having to believe they can ship hundreds of thousands of Ads to each person each month, or can sell online goods - ie demi-freemium funding - but that typically only attracts c 5% of users, so you are looking at $20 per month per paying instead.

My take - Don is right, the good assets are expensive, but $50bn is a valuation based on a microstake. Goldman Sachs are not fools, but this is basic bubblenomics - and bubbles are built on the Bigger Fool Theory, ie there will be bigger fools who will buy these shares from Goldman. When you see private Facebook shares being sold to the "Man on the Street" its time to run for the hills. (In fact it may be time now, as Goldman is apparently setting up to letting its wealther clients co-invest to the tune of $1.5bn. Next short step, the pension funds.....)

But the more worrying point is the whole issue of what happens if the whole market (or a large proportion) moves to what is is essentially a "Private IPO" vehicle. Why go through all the hassle of public reporting and scrutiny of your accounts, just get (bailed out) banks to give you large lumps of (nationally subsidised) money. No worries about a trade sale either, and all those inconvenient due diligence studies and new managers telling you what to do. This is Bubble 2.0 behaviour, and if it was repeated over and over you wind up with a large number of impenetrable investment vehicles in large companies that are "too big to fail", backed up by banks that are "too big to fail". Which is a recipe for a nasty post bubble crash - as we have very recently learned with sub prime mortgages. Which brings us to watching to see what the SEC does - Bloomberg:

The Securities and Exchange Commission, whose rules require any company with more than 499 investors to disclose financial information, is already scrutinizing the market for trading shares of closely held companies including Facebook, according to a person familiar with the inquiry, who declined to be identified because the matter isn’t public.

The SEC’s rules state that if a vehicle is set up “primarily to circumvent” securities law, the beneficial holders will be counted as individual owners of record. Let us see what they do here............but my concern is that the SEC is now too busy locking the subprime mortgage gate, post bolting horse, and fighting that last war - and won't see the next scam until it's too late.

Update 1 - apparently the SEC are already looking at early closed share dealing in Facebook et al, so it may be my worries are premature. Still worth watching carefully

Update 2 - Dealbook wonders if this may just be a preparation for an IPO, since if Goldman sells more than 499 shares (actually, something less as there are already some shareholders) then Facebook has to start reporting its financials publically, and when Google was in that position it chose to IPO.:

However, if a company exceeds the 500-shareholder limit, then it is only required to start reporting within 120 days of the last day of its fiscal year it exceeded this amount. If Facebook has a fiscal year that coincides with the calendar, this would give the company until May 2012 before the requirement takes effect. So Goldman’s investment may be exactly in contemplation of such an event next year.

Maybe, but to IPO several tens of % of it's shares at $50bn is a tougher ask than getting subsidised cash for 1% at $50bn

Update 3 - James Governor makes an interesting point, re private control of tradeable Facebook shares creating an artificial scarcity:

$500m is the new $5m. special purpose vehicle = artificial scarcity

Update 4 - good point by Gordon Rae in the comments - for Goldmans, the valuation is irrelevent, the investment here is just a stake to get the ongoing fees - they will be out the shares long before anything goes awry.

*The one sure thing you can tell from this is that Facebook clearly can't self fund itself enough for what it needs, even on $2bn turnover a year.