Inflated valuations caused breakdown in talks between Facebook and Twitter

2 Dec 2008

The first major consolidation of the social-networking age – the merger of Facebook with rising star Twitter – may have been derailed by questions over Facebook’s inflated valuation, a leading analyst has claimed.

Facebook’s attempts to woo Twitter with an all-stock offer fell on deaf ears, and it appears the social-networking giant’s valuation seems to have been the sticking point, said Madan Sheina, principal analyst at Ovum.

But, since neither company, as yet, is able to demonstrate that it can make money on a scale that matches its number of users, the outcome might not be a bad thing, Sheina added.

Acquisition talks between two leading Web 2.0 social-networking sites, Facebook and Twitter, fell apart last week. Facebook was tabling a US$500m all-stock offer for Twitter.

“That might seem like a high watermark for a Web 2.0 firm, but apparently it wasn’t enough for the micro-blogging site. But could Twitter really look at itself in the mirror and justify a higher price, or even that price for that matter?,” said Sheina.

“After all, it is still without a revenue-generating business model. Plus, its ability to send mini-text messages (‘Tweets’) of 140 characters or less on the internet or mobile phones is a clever idea, but hardly rocket science, and certainly doesn’t come with a natural money-making model,” she added.

“Putting a value on Twitter’s shares, however, creates a big sticking point for privately held Facebook – which is setting a value on that stock. Valuations are typically based on the company’s last transaction. In Facebook’s case, its valuation has reportedly been set at around US$1bn, largely thanks to Microsoft’s US$240m stake 13 months ago for greater advertising rights.”

With the worlds economies spiralling into a downturn, that figure might seem to be exaggerated right now.

To put it into perspective, Sheina pointed out that Facebook’s valuation exceeds that of Yahoo! and eBay, both of which have profitable business models, although their valuations have dropped recently. “Plus the valuations of these kinds of similar ‘dotcom-esque’ internet firms have dropped substantially – Google has shed around two-thirds of its value, and News Corp, the parent firm of rival social-networking site MySpace, is trading at a third of its 52-week high right now.”

Facebook, Sheina said, seems intent on leveraging its US$15bn valuation to flex its muscle and try to broker any kind of deal before it drops. “But the first thing that Twitter’s management will probably have thought is whether the stock is actually worth US$500m or not.”

Sheina said rejection might not be a bad thing for Facebook. “On face value, combining two of the world’s leading social-networking sites seems like a perfect match. Facebook has its own basic Twitter-like features, and Twitter lacks the more advanced social features of Facebook. Twitter also has innovation in certain areas, such as status update, that Facebook can benefit from.

“However, on a corporate level, a merger could be a mismatch. Twitter has yet to sketch out plans to monetise its blogging site. Revenue has always been an issue for Facebook, and Twitter’s high SMS costs related to the delivery of its messages to mobile phones in some international markets does not really address that. One way to generate revenue is to target corporate users with some kind of value-added business messaging service.”

While Facebook has never stated its intention to address corporate business communications like its professional sibling, LinkedIn, it does seem keen to follow an advertising model, whereas Twitter has never pursued this path or indicated an interest in it – as yet anyway.

“Twitter would certainly be a nice addition to Facebook’s stable, but it isn’t necessarily going to take Facebook into new revenue-generating markets,” Sheina suggested.

“Rather than grab a company that has yet to make a cent, a bigger revenue opportunity for Facebook would be to either compete with or acquire LinkedIn.

“However, the fear of Twitter falling into the hands of a rival like Google or Yahoo! might well be enough to justify another swoop by Facebook at a later date.”

By John Kennedy

John Kennedy is a journalist who served as editor of Silicon Republic for 17 years