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Five Reasons To Be Wary Of Facebook’s Valuation

On the back of investment by Goldman Sachs, Facebook’s current valuation is skyrocketing. But here are five reasons for skepticism.

Is Facebook overvalued? Of course it is.

There's no question that Facebook is a great company and deserves a rich valuation. With a reported $400 million in profits and $2 billion in revenue for 2010--up from a reported $200 million in profits and $770 million in revenue the year before--Facebook certainly qualifies as a real business, and a fine one at that. It is light years beyond the dot com blowups of the past, and with a diversified revenue stream that includes commerce transaction fees as well as the more volatile source of advertising, there is good reason to expect its supercharged growth phase to continue for quite some time.

But alas, everything has a price, and the $500 million investment by Goldman Sachs and Digital Sky Ventures simply gets ahead of the story.

The deal values the company at $50 billion, or 25 times sales, and that seems aspirational. Facebook may well grow into that valuation, but it isn't there yet.

Here are a few reasons why skepticism is in order:

1. Facebook founder and CEO Mark Zuckerberg reportedly wants to validate private market transactions that value the company at as much as $57 a share, so that it will have more weight and leverage as it strikes commercial agreements with other companies. That might serve his limited purpose, but it gets away from a valuation based on the business itself. That is a little scary. 

2. The outlier valuations in the private market ought to be viewed with caution, because the biggest bulls on this company have gone crazy. There is talk that Facebook will become the largest company in the world, or that its currency will replace cash itself. That is a speculative proposition to say the least. 

3. Facebook's valuation has gotten too far ahead of rivals such as Google, which makes more money per user. Google is trading at 25 times earnings, not sales. Facebook is now valued at more than 50 times

earnings.

4. Goldman's participation in this deal can't be viewed as an endorsement of Facebook's valuation. Goldman can make money on Facebook from IPO fees and other sources, and profit even if Facebook's valuation falls. Goldman clients are paying big fees to invest in a special purpose vehicle that will own private shares of Facebook, and they won't make money unless Facebook appreciates in value.

5. The New York Times, which first broke news of the deal, says today that Goldman's private equity arm passed on Facebook because of concerns over valuation. Who are you most likely to trust--Goldman's private equity group, which has a fiduciary duty to its clients, or the market makers and sales staff at the bank itself, who have no such obligation to the client?

Facebook at more  than 50 times earnings is a stretch—even considering all the company's remarkable strengths.

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