Buying Facebook will not save Yahoo!'s face

Posted Oct 11th 2006 2:45PM by Peter Cohan
Filed under: Deals, Management, Competitive Strategy, Google (GOOG), Yahoo! (YHOO), Employees

Facebook, the college and secondary school social network, is rumored to be for sale. Several potential acquirers are looking at Facebook as a way to save face after they passed on scooping up MySpace and YouTube. There are many different markets which will pass judgment on the deal – including the markets for stocks, financial statements, media buzz, and talent. My colleagues Sarah Gilbert and Melly Alazraki have commented on what Yahoo! Inc. (NASDAQ: YHOO) should do next. I think Yahoo should pass on Facebook.

I think the decision about whether to move forward with a Facebook buy depends on which of these markets matters most to the acquiring company's management. Different markets judge strategic decisions through different lenses. Here's how:

The stock market rewards technology companies that appear to be on the cutting edge of technology and that grow faster than analysts expect. If Wall Street thinks that a merger will boost growth, the acquirers' stock will rise on the announcement of the deal. In the case of Google Inc.'s (NASDAQ: GOOG) acquisition of YouTube, Google's stock market value rose $2.6 billion during the day preceding its announcement of the deal – more than offsetting the $1.65 billion purchase price;
The market for financial statements is related to the stock market – but it's different because it exists in the minds of managers who make decisions based on rigorous financial analysis. Such rigor can slow down the deal-making process and cause companies to pass on acquisition opportunities because they are not certain of their precise financial impact. They fear overpaying more than they fear missing out on a potentially large opportunity;
The market for media buzz is surprisingly important. Managers savor the press interest in their decisions – particularly if that interest is favorable. During the 1990s, tech companies would try to get their product into the hands of investment bankers who did initial public offerings. Now, if an acquirer buys a company that the media uses – such as YouTube -- it can rely on getting significant media attention when the deal goes down; and
The market for talent must also be considered when doing a deal. If a company's employees hold stock options which are worthless because the company's stock price has declined, then the talent will leave for a company with a bigger potential payoff.

Of course these different markets are linked together. Winning companies get them working in unison to create a virtuous cycle in which a rising stock price attracts more talent which develops popular new products that get media buzz, accelerate earnings growth, and provide a higher stock price which it can use to make acquisitions and attract even more talent.

What does this have to do with Facebook? I think it helps explain why Yahoo has not closed the deal announced last month to buy Facebook. Yahoo passed on MySpace and YouTube – both deals were widely heralded in the media and have boosted the stock prices of their acquirers – News Corp. (NYSE: NWS.A) and Google, respectively.

But as reported in today's New York Times [subscription required] Yahoo's stock price has tumbled 38% in the last year and it's losing talent that's holding on to worthless stock options. That talent is getting a salary boost but it pales in comparison to the quick riches available to those who own stakes in these startups. Some Yahoo veterans have taken the bait. For example, Mike Murphy, a longtime ad salesman, is now the chief revenue officer of Facebook, and Gideon Yu, Yahoo's treasurer, quit in September to become chief financial officer of YouTube.

Moreover, Yahoo is being chided in the press for its conservative financial management which slows down its decision-making and has contributed to its missing out on these deals – leaving it under media and stock market pressure to do a "hot deal" in order to save face.

But does such a deal make sense for Yahoo? Yahoo certainly has a weaker currency for acquisitions than Google to which it is losing deals and talent. For example, Google has $11 billion in cash and a market value of $131 billion, while Yahoo has $4 billion in cash and is worth $34 billion.

This means that it can afford less to overpay. And the price tag on Facebook is mighty high. Facebook had 14.7 million unique visitors in August 2006. Based on the $1 billion price tag being discussed in the media, Facebook is less than half the size of MySpace when it was acquired, even though the Facebook price is almost double MySpace's $580 million.

Moreover, if Yahoo does move forward it will be paying more than it has for previous private company deals. For example, in December 2005, Yahoo! paid $20 million for social bookmarking site del.icio.us which had 300,000 registered users – Yahoo paid roughly $66 per user. The Facebook acquisition would mean paying $111 per registered user, 68% more.

But a comparison with MySpace is misleading because of the tighter privacy settings on Facebook. For example, the typical user can see less than half a percent of Facebook's total user profiles. That is in stark contrast to MySpace, where everybody can basically see everybody else if they know where to look. This could conceivably limit the value to advertisers of Facebook's registered users.

Simply put, if Yahoo buys Facebook, it could reinforce the opposite of the virtuous cycle I described above. Namely, such an acquisition could add to the vicious cycle that has already propelled Yahoo's stock downward 38% this year. Specifically, the stock market could conclude that Yahoo overpaid which might cause its stock to fall, thus generating bad media buzz, disappointing earnings, and a further talent exodus.

Buying Facebook to save face might not be Yahoo's best option.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College. He has no financial interest in Google, News Corp., or Yahoo.

Tags: facebook, goog, google, myspace, yahoo, yhoo, youtube

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Reader Comments (Page 1 of 1)

10-11-2006 @ 4:18PM

Dennis Goedegebuure said...

There is something more on the last point you make, the market for Talent. If employees make a S*** load of money in such sell offs of a company, they are most likely to leave as well, as they have enough to retire. This may cause the acquirerer with a company without the talent it had hoped for.

10-11-2006 @ 4:52PM

mom said...

when my daughter comes home from college breaks, face book is always on. i dont see what kids find so interesting? anyone know?

10-11-2006 @ 6:00PM

Randy Smythe said...

Peter - excellent post! I agree with you. Yahoo should stay away from Facebook as a purchase. I would suggest instead that they invest much less than $500 million on developing and marketing their own Social Networking solution. How many of Facebooks’s 14.7 million unique users already use Yahoo for email or some other function? They would be much better off spending a lower amount to create their own site rather than spend $1 Billion or more for Facebook. Yahoo, has the in-house talent for this task they should enable some of these talented employees to develop their own site.