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How to Value Social-Networking Companies

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Gauging the valuation of private companies can be tough, but that hasn't stopped investment bankers from drooling all over themselves as they look ahead to potential multibillion-dollar IPOs in the social-networking space. Heck, Wall Street even has its own self-proclaimed social-media analyst now, in Lou Kerner. Brilliant! These guys are all over this trend.

We've seen some big numbers thrown around for the likes of Facebook, Twitter, Groupon, Zynga, and LinkedIn. Zynga's value has been pegged around $10 billion, well beyond traditional gaming powerhouse Electronic Arts (Nasdaq: ERTS  ) , while Groupon thinks it's worth considerably more than the $6 billion that Google offered.

And then there's the king of all social media -- no, Rupert, not News Corp.'s (NYSE: NWS  ) soon-to-be-former debacle, MySpace -- but Facebook, which has seen valuations in the $80 billion range.

Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) head honcho Warren Buffett apparently won't be among the buyers when these companies go public. He's said that "it's extremely difficult to value social-networking-site companies" and that "most of them will be overpriced."

But let's face it: He's old and probably wrong.

To help Wall Street show Warren and the other doubters why these companies are worth going gaga over, I've come up with a few handy valuation metrics.

Price-to-Friends. Forget focusing just on users. With Facebook and other social-networking sites, we're going to focus on friends. Facebook has around 500 million users, and each user has around 130 friends, so there are currently 65 billion friends on Facebook. Value each friend at oh, say, $5, and Facebook is worth $325 billion. Count me in!

Price-to-Tweets. Is there a clear value to a tweet on Twitter? No, but there could be, right? According to The Huffington Post, Twitter currently handles a billion tweets per week, and daily tweets have grown from 50 million to 140 million in the past year alone. With that impressive 180% growth at its back, we have to at least put a multiple of 5 on current tweets. That would give Twitter a valuation of $260 billion. Now that's worth retweeting.

Price-to-Levels. On Zynga games such as FarmVille and Mafia Wars, players advance by achieving higher "levels." I've estimated that roughly 50% of my Facebook friends are on at least one Zynga game, which would mean that around 250 million of Facebook's total users are playing Zynga games. After a short stint on Mafia Wars last year, I'm at level 128. Assuming most users have reached just this low level, we're looking at 32 billion levels. With a price-to-level multiple of just 8, we've got a $256 billion valuation for Zynga. Plant that in your farm, you naysayers!

I'm sure there are plenty of other Fools who'd like to help Wall Street value these social-media companies, so go ahead and share your valuation techniques in the comments section below.

Berkshire Hathaway and Google are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers pick. Berkshire Hathaway is a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway and Google. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway but of no other companies mentioned. See what Matt's keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (6) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 26, 2011, at 1:53 PM, bottomfisherman wrote:

    Facebook does not have 500 million users. They have 500 million accounts there is a difference. Users set up multiple accounts on there some as few as 2 or 3 and some over 10. It is difficult to judge the value of social networking companies based upon these high "user" figures they just are not accurate. Social networking is going to be a big bust and is a fad that is going to pass quickly when the next big thing comes along, so count me out.

  • Report this Comment On March 26, 2011, at 4:29 PM, buffalonate wrote:

    I wouldn't buy stock in any social network company. There is very little barrier to entry just ask myspace. Most of them don't make much money. Even Facebook only makes 500 million a year. Social media is a buzz word that makes peoples value stocks at prices that have nothing to do with actual earnings.

  • Report this Comment On March 26, 2011, at 9:46 PM, vidar712 wrote:

    To me, Facebook is more like a newspaper company or a television station. They sell advertising to a large group of people. The only real difference is that Facebook doesn't have to buy paper and ink, or pay writers to create content. The users are the content. So, the revenue might be the same, but the margins should give facebook an edge over other advertisement companies..

    My prediction: Facebook will IPO and be overpriced. It will then become even more overpriced. It will reach its peak and be stagnant for a decade or so until that price is justified by its earnings.

  • Report this Comment On March 26, 2011, at 10:44 PM, neamakri wrote:

    Facebook 65 billion friends?

    How many planets/solar systems are you including? Get real.

  • Report this Comment On March 27, 2011, at 9:14 AM, Birdtrax wrote:

    First off I am not beating the drums for Facebook but everyone is really missing what Facebook is. They really thrive on users information and the rights to sell that information. They also are a very good search engine. I like MLB (baseball) so I like the MLB page and all my baseball news flows to my page, a reverse search engine somewhat. I think Facebook is pushing new apps such as e-mail will be coming and more. I would not be afraid to buy in, I bought Google at $85 as an IPO and made out very well.

  • Report this Comment On April 06, 2011, at 3:30 PM, renitentInv wrote:

    What i want to know is where that valuation for a tweet came from. Based on how I see twitter being used a tweet is probably worth more like the value of a coupon ... 1/100 of a cent. (i.e. as worthless as the person who bothered to tweet)

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