Do I Hear $210 Billion for Facebook?

06/28/2011 10:00 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Shares of closed-end fund GSV Capital soared after it scored Facebook shares valuing the social networker at $70 billion. But investors will end up paying GSV even if it’s very wrong, writes senior editor Igor Greenwald.

If he wasn’t busy slaughtering livestock Monday evening, Mark Zuckerberg could have done some fun and easy math on how much his pet project might be worth.

And then the founder of Facebook might have sacrificed whatever animal was handy to appease the extremely generous gods.

The privately held Facebook’s worth has been something of a mystery, just like an up-to-date count of its users. Pending an initial public offering widely anticipated sometime next year, Facebook shares trade only on secondary markets available only to a small number of accredited investors.

There is no publicly quoted daily price, only the occasional announcements of private placements.

When Microsoft (MSFT) invested $240 million in Facebook in late 2007, the deal valued the entire company at $15 billion. At the peak of a market that would lose more than half its value in the ensuing 18 months, $15 billion for Facebook (with all of $150 million in annual revenue and 42 million users) seemed a bit rich.

Yet by the time Goldman Sachs (GS) got Facebook to take $450 million of its foreign clients’ money this past January—half a billion new users and a hit movie later—$50 billion seemed about right.

Until Monday. That was when the fledgling GSV Capital (GSVC) announced it had scrounged up 225,000 shares from former Facebook employees at an average price of $29.28 per share. Since there are an estimated 2.4 billion Facebook shares outstanding, this values the company at $70 billion.

GSV, which raised $46.5 million in its own barely noticed IPO two months ago, bills itself as a closed-end fund investing in “privately-held, venture capital-backed, rapidly growing companies.”

GSV’s founder is Michael Moe, a San Francisco financier and author who claims to have identified Starbucks (SBUX) as a big winner back in 1992. Moe also founded and later sold the boutique research shop ThinkEquity.

But perhaps most impressively of all, he served as director of global-growth stock research at Merrill Lynch from 1998 to 2001, without so much as a hint of taint from the research scandal centered on colleague and onetime coauthor Henry Blodget.

I’ll quote a bit from their joint effort, “The Knowledge Web,” because it seems so germane to the question of Facebook’s valuation. Keep in mind that the opus on opportunities in interactive education came out just as the Nasdaq had plunged from more than 5,000 to barely 3,000 in the space of ten weeks.

“We believe that once the leaders are identified and become public companies, we will see the same valuation characteristics that have accrued to other leading Internet companies. These valuations, while dramatic compared to many offline companies, may indeed prove to be reasonable when compared to the size of the opportunity in this market, the potential for early leaders to accrue a significant share and the high gross margins they enjoy.”

This ultimately proved true for two of the examples cited, Amazon (AMZN) and eBay (EBAY), but not so much for Yahoo (YHOO), which then led the race for users (with 120 million) and was valued at $74 billion. Or AOL (AOL), for that matter, which bloated to $131 billion after merging with Time Warner. Proving that no one can win them all.

But anyway, this is where Moe is coming from when he tells Fortune that he got a bargain in that $70 billion valuation of Facebook. And he’s also coming from last week, when other Facebook shares were auctioned off, at an implied value of $84 billion for the whole shebang, on the secondary market.

Not only that, but Moe apparently has made a lot of fast friends who like how he’s thinking. Because GSV shares didn’t tread water, as you might expect if the market thought $70 billion was a fair value for Facebook.

Instead, having sunk inexplicably from $15 to little more than $10 in the two months since the IPO, GSV shares recouped almost all of that loss in a single day, regaining $14 million in value after a 42% leap.

That’s a $14 million reward for buying $6.6 million of Facebook stock at the recent going rate.

So, attributing GSV’s entire daily gain to the perceived value of its investment in Facebook, it’s possible to conclude that Facebook is actually worth three times what Moe paid, a nifty $210 billion.

That seems as silly as $15 billion seemed four years ago, but does stand a much better chance of still seeming silly a decade from today. Large numbers are a drag—just ask Apple (AAPL), which is going to earn $24 billion this year and is being valued at less than 13 times that.

But of course, GSV’s price spike doesn’t represent any sober assessment of the value of its Facebook shares. It was more about GSV’s scarcity value as the only way for most investors to buy into Facebook.

 The investment will account for 15% of a portfolio to be fleshed out in the coming days, but for now it’s just Facebook and Kno, a developer of textbook apps for the iPad.

Considering that the hype around Facebook will only grow as the IPO approaches, GSV could well ride the coattails higher from here. Its own performance Monday speaks to a pent up demand for a Facebook stake from many of the denizens of Farmville.

On the other hand, GSV’s success—if it has any—will not come cheap. It’s paying the related-party asset manager, led by Moe, the going hedge-fund rate for portfolio management: 2% of gross assets plus 20% of cumulative profits.

On top of that, the company’s IPO prospectus anticipated the expenditure of another 3.26% of assets for annual expenses. Which, I’m assured, includes the administrative expenses paid to another related-party company, so that’s a relief.

All in all, investors in GSV can expect to pay more than 5% annually for the privilege of profiting should the closed-end fund eventually realize a capital gain.

And if that seems like a good deal, I’ve got a virtual tractor to sell you.

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