Why is Facebook worth more than Yahoo?


Mike Arrington at TechCrunch published a ‘valuation metrics’ for social networks yesterday. Read the whole article here.

What struck me is that somehow Facebook seems to be getting a significantly higher valuation than companies with comparable business models, for example Yahoo. How can that be right?

Let’s take a step back and think this through. The valuation of a company corresponds to its ability to generate revenue, to do so profitably, being able to grow fast and have a high probability that the revenue is not going to dry up soon. All this depends on a company’s business model.

As far as I am aware, there are only a few ways in which you can generate revenue on the Internet. Each of these revenue opportunities converts usage into money. Different business models are doing so at different rates:

Business Model

…version with notes:

Business Model

Using this (admittedly very rough) estimate, we see that Search is a superior business model in terms of converting traffic into revenue.

Taking a cut of a real world transaction (eBay) also converts traffic well into cash.

Premium subscription and advertising work equally well, both at some 1/3 of the efficiency as Search.

Back to the original question: how is Facebook running a different business to Yahoo and why should Facebook be able to command a premium valuation above and beyond of Yahoo’s? They are both mainly display advertising-based businesses.

At best, Facebook can command a valuation that is in line with what companies like Yahoo can command. I have read many reviews where people criticised Facebook’s advertising programme, but let’s leave that aside for the moment.

Yahoo’s market cap today is some $30bn. If we (roughly) attribute half of that to its search business and overseas activities, then the market cap based on US display advertising would be roughly $15bn. If Facebook can generate some ¼ of Yahoo’s traffic, and if it has some 50% efficiency of converting traffic into revenue, then it should have some 1/8 of Yahoo’s value. (Maybe slightly higher, if you take into account that Facebook is growing rapidly. Maybe slightly lower, if you take into account that Facebook is not profitable.) Let’s say that is $2bn.

Unless Facebook (or any of the other social networks for that matter) can come up with a better way than display advertising to monetize its traffic, then the way in which it should be valued shouldn’t really be different from the way in which Yahoo is valued.

What is remarkable about Facebook is not its amazing ability to convert its traffic into revenue (it is not a Google). What is amazing is how quickly it managed to grow its traffic. It grew from nothing to 35 million users in four years. Now that is amazing and that is the real strength of social networking. You can grow a great business in a very short period of time. But the monetization is still dependent on the display advertising business model. I guess you can’t have it all.

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