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News arrived today that, as predicted in this blog over two months ago, Microsoft would be investing to own a bigger piece of Facebook and would do so at a valuation that implies they ultimately believe that Facebook will be worth around $100 billion.  Given that Microsoft was only allowed to buy 1.6% of Facebook for their $240 million (implying a present valuation of $15 billion) and given that Microsoft (along with the hedge funds that may put in another $260 million) like to see a return on their investments, it seems clear that Microsoft and the hedge funds are looking for at least a 7x return on their money (i.e., around a $100 billion future valuation of Facebook).

As I explained to Michael Arrington from the audience at the Dave McClure’s Graphing Social Patterns conference, “valuation” is what a willing buyer and a willing seller agree it is. So, Mark Zuckerberg and Steve Ballmer have agreed that 1.6% of Facebook is worth $240 million implying an overall valuation today for Facebook of $15 billion. However, I’m still confident that Mark Zuckerberg (and Steve Ballmer and I), actually values all of Facebook at around $100 billion. This higher valuation is for the entire company and uses Warren Buffett’s model based on the future cash flows (or Owner’s Earnings) that will come from the business.

For those, like Michael, who say $100 billion is “crazy” or “bubble talk” or “call security time,” I would invite them to engage in the following thought experiment based on three assumptions:

1. Facebook active users count grows to 200 million by Dec. 2008 – this seems highly likely given that facebook already has 49 million users and is doubling every six months. In fact, Facebook will cross the 50 million active user count two month’s sooner than I had predicted in my earlier posts. In addition, Facebook is just now starting to grow in the US business world (even without yet releasing their friend groups feature which will put a nail in LinkedIn’s coffin) and internationally (even without yet offering any localized sites which should be coming soon). This 200 million users by Dec. 2008 assumption ignores the even greater growth that could occur with a little help from the 600+ million users of Microsoft Windows and Office which Steve Ballmer’s team could coax into having facebook accounts by simply updating how new versions of Microsoft’s key software products are installed.

2. Facebook cuts one deal with a major search player to power their web search — given the time spent by facebook users inside of facebook and given that a search box lives in the left-hand nav of every facebook page, it seems quite possible that the half of all facebook user who come to the site every day might do at least one web search (when Facebook picks a partner to power their web search). So for 2008, this works out to 100 million * 0.5 * 365 days = 18 billion web searches per year. Google handles about 64 billion US web searches per year and monetizes these searches at around $0.26 per search == $16 billion. Assuming Facebook’s search engine partner only monetizes these at $0.13 per search due to their relative lack of Cost Per Click search inventory and facebook users’ dislike of leaving facebook, this still works out to $2.3 Billion in search revenue in 2008 and $4.6 Billion in search revenue for 2009. Assuming their search partner takes 20%, this leaves $1.8 billion in 2008 and $3.6 billion in 2009 for facebook. Not bad for a business that is ultimately no more complicated than Facebook signing an “AdSense for Search” type of deal with Microsoft, Yahoo or Ask.

3. Facebook opens an online shopping mall in facebook for the top 1000 cataloger, e-tailers and retailers — the model here is that since Facebook users love to stay inside of Facebook, why not build them a OneCart shopping mall (e.g., like SHOP.COM) that brings all the important merchants and all of their products into a single consistent shopping experience with a single store navigation experience, a single shopper account and a single checkout across all the merchants? Amazon would certainly pay $1 to $2 billion per year to Facebook to power this experience. However, I think Facebook will do better by acquiring SHOP.COM’s patents, brand, 20+ expert e-commerce engineers, 1,000+ vetted merchants and 10+ million products and owning this transactional monetization method themselves. Assuming each store’s base mall rent was $1 million per year to be a part of the new facebook universal shopping cart and each store agreed to incremental overage rent of 5% of gross sales within the facebook mall, this works out to a minimum of $1 billion per year in base mall rent for facebook in 2008 and even more in 2009 as the user base in facebook grows (which would justify a higher base rent) and the overage rent really starts to kick as more folks are trained to actually buy products inside of facebook based on their friends’ active and passive recommendations.

So, with these three simple assumptions, facebook would have revenue of $2+ billion in 2008 and $4+ billion in 2009. Almost all of this revenue will fall straight to facebook’s bottom line because their projected burn rate of $100 million (assuming 1,000 employees by the 2008 - 2009 time period) could be covered by a smattering of contextual, demographically targetted banner ads and ads on the login page.

Under this model, a $100 billion IPO valuation would only be 50 x 2008 earnings and 25 x 2009 earnings.

So, congratulations to both Microsoft and Facebook. To Microsoft because they’ve kept Facebook a “Google-Free Zone” (and this will ultimately let them dethrone Google from their current position in the online advertising eco-system). To Facebook because this $240 million (growing to $500 million) warchest will allow them to hire and/or acquire the resources necessary to defend their birthright to be the dominant Social Operating System in the key markets of the world.

Lastly, hats off to Dave McClure, Rodney Rumford, Ellen McGirt, Jessica Guynn, Brad Stone, Nick ONeill, Justin Smith, Teresa Valdez Klein, Dustin Moskovitz, Chamath Palihapitiya, Dave Morin, Jim Breyer, Paul Madera, Owen Van Atta, Randi Zukerberg, Mark Zuckerberg and Steve Ballmer. You’ve all helped me see through your blogs, articles, stories, comments and actions just how important Facebook will be to the next 20 - 30 years of the software industry.
Thanks,
Lee Lorenzen
CEO, Altura Ventures LLC — the first facebook-only VC

(c) 2007 Altura Ventures LLC.