Valuation multiples in social media companies

By Xavier Forneris

In a recent post I discussed the issue of valuation for internet businesses in general and social networking companies in particular. I mentioned several examples of successful and not-so-successful initial public offerings (IPO’s) to illustrate the valuation issue. An IPO is not a requirement to make valid observations on the value of firms. When these companies are still private, what private equity, VC firms and other investors pay for a share of these companies, in private transactions with the founders (usually) allows to determine their overall value. The topic of social media valuation is not an acamedic but a very practical one. Implicit in my question is the concern that the public may be paying too much for a share of the social media boom and some have asked whether a new “internet bubble” reminiscent of the collapse of the dot-com market in 2000 was in the works.

And I’m sure many of you are familiar with the case of Skype, which eBay purchased in 2005 for $2.6 bn. At the time that represented 350 times Skype’s annual revenues. About 2 years later eBay took at $1.4 bn write down on its investment. In 2011, it was purchased by Microsoft for $8.5 bn, which meant a much more modest multiple (about 10, down from 350).

I must admit that I find the valuation multiples in the sector a little nerve-wracking. What matters is not the size of an IPO or how much a company is valued at, but what the valuation represents relative to the company’s annual revenue (sales). For example, when LinkedIn was valued at $9 bn after its successful IPO, this means that it was valued at 45 times its annual revenue of $200 m, or in “finance speak”, a multiple of 45. With annual revenue of $150m, Twitter‘s recent valuation at $7.7 bn means a multiple of 50. Zynga, the San Francisco-based maker of social games (such as CityVille and FarmVille) is due to have its IPO and start trading this coming Friday (Dec. 16) on NASDAQ. Zynga said it plans to sell 100 million shares at a price range between $8.50 and $10 per share. That would raise $1 bn, making it the biggest US Internet IPO since Google in 2004 (which I mentioned in my previous post) and giving the company a total market cap of $7 bn. For the nine months ended Sept. 30, Zynga claimed total revenue of $829 m.

If Facebook does an IPO in early 2012 that values the company at $100 bn, that would mean a multiple of 50, based on annual revenue of about $200 m. Based on its recent valuation at $75 bn, Facebook’s current multiple is about 37.5.

Looking at “typical” multiples, industry by industry, would help put things in perspective. Unfortunately, there’s no “commonly agreed multiple”. Different experts use different valuation methods. Valuation multiples vary from industry to industry; even businesses in the same industry sell for widely ranging multiples. Multiples also vary with the state of the overall economy, the stage of development of a company, or the reliability of its financial statements.

This being said, I want to quote a post by Michael Gravel on “Internet Application Software Business Valuation Multiples” (June 24, 2011):

A review of the 47 announced transactions within the Internet software and application software sector for the past eighteen months establishes a range (per individual announced deal) of business valuation multiples from .06x on the low side to 9.3x of gross revenues on the high side with the majority of the deals falling within 1.8x to 3.4x multiple of gross revenues.

These multiples, in an industry that is not too distant from the one we’re discussing, are much, much lower. But this does not necessarily mean that valuations for social media and internet firms are wrong or deceptive, nor that people behind these vlauations are over-optimistic or delusional. But it’s certainly justifies wondering whether investors are paying too much and whether such sky-high multiples can be sustained over a long period of time. Hence the concern, often raised in the blogosphere, of a possible “social media bubble”.

Another way of looking at this is to ask whether the social media companies will eventually realize the potential that investors have seen in them, in other words if their revenues will go up significantly, which would then bring the multiples to a more “reasonable” level. At least the companies I mentioned above have revenues. In his May 26, 2011 blog post “INFOGRAPHIC: The Soaring Valuations Of Social Networking Companies”, Kris Holt mentions two companies that have no revenues and a nice valuation (although not in the billions): Color Labs, valued recently at $41m and delicious valued between $15m-$30m, also with no revenues. Investors in these two companies are evidently betting that this situation will change and that they will be able to cash out.

I encourage you to read Kris Holt’s post on Scribbal, which includes a great infographic published by G+ (gplus.com). Below my post I provide the links for both Kris Holt’s post and for the original source of the infographic. I also welcome your views and comments on the tricky question of valuation for social media and internet businesses.

Sources / Read more:

http://www.imergeadvisors.com/2011/06/internet-application-software-business-valuation-multiples

http://www.scribbal.com/2011/05/infographic-the-soaring-valuations-of-social-networking-companies/

https://www.gplus.com/Editorial/Detail?seoName=INFOGRAPHIC-Is-there-a-Tech-Bubble&topicNames=Social-Media

http://www.minyanville.com/businessmarkets/articles/thestreet-zynga-zynga-ipo-internet-stocks/12/2/2011/id/38190

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