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Goldman Sachs Reveals Concern About Facebook Offering

Goldman Sachs' private placement in Facebook has unearthed a flood of new data about the privately-held company's growth.

Goldman Sachs' now-notorious private placement in Facebook, valuing the social network at $50 billion, has unearthed a flood of new data about the privately held company's growth. The media attention has led to questions about whether the deal constitutes a public offering and even if it doesn't, whether the sheer volume of coverage violates SEC rules banning the pre-marketing of private placements. That concern led Goldman to announce last Sunday that it was limiting the offering to investors outside of the U.S., in an attempt to steer clear of a potential problem with the SEC. Outside the U.S., the rules on such placements arent as strict.

Goldman's climbdown probably is a necessary and shrewd move. Yes, it has embarrassed itself and angered wealthy U.S. clients who were ready to buy Facebook shares through a special purpose vehicle that the bank created. Far better, though, to take that hit now than to spawn a larger future problem, such as the need to buy back Facebook shares at a loss for Goldman clients.

Goldman, which paid $550 million last year to settle a civil fraud suit with the SEC, may be pushing the regulatory limits too much and too often. It is under a lot of pressure to maintain its performance. The company reported recently that overall profits fell 52 percent in the fourth quarter. While most of that decline reflected less favorable conditions in trading, it can be attributed in part to a decline in revenue from investment banking. The company also told investors that the backlog of investment banking deals was down from the third quarter. Given that decline in deals, its not surprising that Goldman may have pushed the envelope when it came to the Facebook offering.

The main question going forward is whether Goldman was too aggressive in forecasting Facebooks revenue growth. Leaked documents, widely reported in the press, showed that Facebook generated $1.2 billion in revenue and $355 million in profit during the first nine months of 2010. eMarketer expects annual Facebook revenue to double to $4 billion in 2011 and $5.74 billion in 2012. The research company estimates that Facebook accounted for 4.7 percent of Internet ad spending in 2010, and that its share will grow to 7.7 percent in 2011 and 8.8 percent in 2012.

As Facebook becomes an Internet platform on par with Microsoft, Google and Apple, there's little doubt that the social media giant will be worth a lot. Even so, there's still plenty of reason to be skeptical about Facebook's $50 billion valuation, which is 100 times 2010 earnings, and 50 times 2011 earnings or twice as high as Googles p-e multiple. (see: Five Reasons to Be Wary of Facebook's Valuation)

As Forbes notes, Google grew even faster than Facebook during its pre-IPO period and its profit margin would rank 25th in the S&P 500. Facebook is a high-growth company with great profits, but it is not in a class by itself. At least not yet.

Adage says, 60 percent of Facebook's $1.86 billion in 2010 revenue came from smaller advertisers, not major brands such as Coke. That isn't necessarily a bad thing, but it creates the potential for problems.

For example, Facebook's third-largest advertiser reportedly is a company called Make-My-Baby.com, which installs a toolbar and tries to direct users to Microsoft's Bing search engine. Facebook has denied that the company is an advertiser at all, although it may be an affiliate of advertisers on the site.

The presence of such questionable companies on Facebook, combined with concerns about they privacy of users and the safeguarding of their data creates a risk for its continued growth trajectory. Just this week, Facebook was forced to cancel a new feature that allowed users to provide cell phones and addresses to app developers. The feature is being retooled, because it made it too easy for spammers to obtain valuable data.

Over time, these features may turn out to be at odds with the sort of environment that major brands and other legitimate advertisers desire.

Facebook isn't the first company to go viral on the Web, and it wont be the last. It seems unassailable now, but so did Google and Microsoft. There are already potential rivals such as the open-source, decentralized and privacy-oriented Diaspora, now in development mode, that are lining up to take a shot at the leader.

This is not to suggest that Facebook isn't a great company, or that its best days are behind it. Its an easy company to love. Maybe too easy. And that can lead to valuations that get ahead of the story.

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