Monday, 13 June 2011 15:59

Did Goldman Just Rip Its HNW and Institutional Clients Once Again? Facebook Growth Slows Pre-IPO, Just As We Warned!

Summary: As our research illustrated in explicit detail 5 months ago, Facebook's growth is slowing after an outrageously rich offering of private shares. Now, I'm sure that GS can put on the ole' shuck & jive show to garner enough interest to cause an initial IPO pop, but then you are basically gambling on investing in Goldman's marketing talents and not the fundamental prospects of Facebook, no?

I have commented several times in the past regarding investment banks who use slick sales and marketing to basically gut unsuspecting (yet often quite monied, which can be considered a paradox in itself) clients. The modus operandi is a combination of hip brand name, say:



or as in this case, Facebook. Goldman Sachs recently pushed Facebook private shares to their HNW and institutional clients at what I believed to be literally outrageous valuations with a lit fuse strategy, ex: Mr. & Mrs. Esteemed Client, decide on buying this mysteriously priced deal in 48 hours (over the weekend) or the deal is off. The more astute clients apparently left Goldman as a result, but GS managed to have get the offering oversubscribed anyway. Far be it for me to disagree with the “U.S. bank that makes the most revenue from trading”, but they have significantly wronged their clients before – many times before. Reference Is It Now Common Knowledge That Goldman’s Investment Advice Sucks??? or Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?for more on this topic.

About 5 months ago I penned "Facebook Registers The WHOLE WORLD! Or At Least They Would Have To In Order To Justify Goldman’s Pricing: Here’s What $2 Billion Or So Worth Of Goldman HNW Clients Probably Wish They Read This Time Last Week!". This was in response to numerous client requests regarding an independent view on Goldman Sachs' Facebook valuation. Below is a brief excerpt or two:

This is the Facebook valuation exercise that I promised to release to the professional (HNW) blog subscribers (File Icon FB note final). As is customary, I am including a material amount for the public blog to chew on. I think most will find it quite the engaging read, at the very least. If you haven’t read my first three pieces on this topic, please do so for you will easily be able to glean my overarching opinion on this most recent Facebook “investment”:

As reported by Bloomberg, the Facebook stock sale throws new light on the Goldman Sachs potential conflicts of interest – conflicts which we have illustrated in full detail in the past. By offering shares to its most favored clients and forcing them to commit or decline in less than a week, Goldman not only made investing in Facebook seem like a precious privilege from a marketing perspective, but made due diligence nearly impossible for those who did not have a dedicated staff with the free resources to throw at the problem in near real time. We, at BoomBustBlog would like to remedy such an issue as what I see is the new face of  investigative reporting and analysis on the web, and will offer consulting services to HNW and UHNW clients who find themselves in similar binds in the future.

I had serious concerns regarding both Goldman's proposed valuation and Facebook's continued growth - to wit: "

" is highly unlikely one can legitimately factor in the type of growth needed to justify the current Goldman $50B valuation – particularly when you consider that Facebook’s growth is already slowing!


Go to 13:00 in the video for more of my opinion on the Facebook offering and the realistic valuation that should be applied to it.

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Well, fast forward 5 months and you find that our concerns and admonitions were very well founded. Inside Facebook has released a study showing exactly what our research warned of 5 months ago - Facebook Sees Big Traffic Drops in US and Canada as It Nears 700 Million Users Worldwide:

Facebook is still growing towards 700 million users, having reached 687 million monthly actives by the start of June, according to our Inside Facebook Gold data service. Most of the new users continue to come from countries that are relatively late in adopting Facebook, as has been the trend for the past year.

But overall growth has been lower than normal for the second month straight, which is unusual.

The company gained 11.8 million more people over May, following 13.9 million over April. In contrast, it grew by at least 20 million new users over the typical month in the past 12; while there have been a few months that have registered lower growth numbers, they have not been back to back.

Why the drop? Most prominently, the United States lost nearly 6 million users, falling from 155.2 million at the start of May to 149.4 million at the end of it. This is the first time the country has lost users in the past year. Canada also fell significantly, by 1.52 million down to 16.6 million, although it has been fluctuating around that number for the past year. Meanwhile, the United Kingdom, Norway and Russia all posted losses of more than 100,000. If these countries — most of whom had adopted Facebook many years ago — had not lost users, and instead posted even small gains, Facebook would have had a much more typical month.

... Still, by the time Facebook reaches around 50% of the total population in a given country (plus or minus, depending on internet access rates in that country), growth generally slows to a halt, as we’ve noted before. So far, Facebook has been able to make up stalls and losses with big gains in heavily-populated developing countries like Mexico, Brazil, India and Indonesia. As you can see in the table above of the ten countries that gained the most users over May, this continues to be the case.

For those that may not have picked up on this, Facebook is exhibiting the characteristics of a company that is either:

  1. a fad;
  2. quickly approaching saturation in its major markets;
  3. or all of the above.

Regardless of which is actually the case, neither circumstance supports, not is good news for, the outrageous valuation that Goldman peddled the private shares of Facebook to its clients for. As a mater of fact, the entire thesis behind the rich valuation was a high growth company that would enrich investors upon an IPO. If growth slows materially before said IPO, then what???

Now, I'm sure that GS can put on the ole' shuck & jive show to garner enough interest to cause an initial IPO pop, but then you are basically gambling on investing in Goldman's marketing talents and not the fundamental prospects of Facebook, no?  Below are additional excerpts from that controversial piece: "Facebook Registers The WHOLE WORLD! Or At Least They Would Have To In Order To Justify Goldman’s Pricing: Here’s What $2 Billion Or So Worth Of Goldman HNW Clients Probably Wish They Read This Time Last Week!" Remember, professional and institutional subscribers should download the entire valuation document here: File Icon FB note final):

Goldman warns, ‘We’re probably going to dump this load, but we may also need you to remain behind to hold the bag!’

In its offer for the $1.5bn stock sale of privately held social-networking company Facebook,Goldman Sachs disclosed that it might sell or hedge its own $375m investment without warning clients. Under the deal, private wealth-management clients would be subject to “significant restrictions” limiting their ability to sell stakes while Goldman Sachs own holding can be sold or hedged at any time, and without warning. One would hope that astute clients and investors would be put on guard by such conflicting and restrictive liquidity measures! In addition, it appears as if Goldman Sachs failed to disclose its clients that it had offered Facebook shares to its internal investment group, Goldman Sachs Capital Partners, headed by one of its star fund managers, Richard A. Friedman.

Since 1992, GSCP has invested its own balance sheet as a principal (that is, on behalf of Goldman itself and its employees) in private equity and has leveraged that investment through funds raised from its institutional clients which include pension fundsinsurance companiesendowmentsfund of fundshigh net worth individuals, and sovereign wealth funds. Unlike most of its (and Wall Street’s) client orientated investment funds, this vehicle actually puts a significant amount of Goldman’s skin in the game (see Even With Clawbacks, the House Always Wins in Private Equity Funds for an example of the implicit call option private equity investors give these fund managers, absolutely free, and the perverse incentive to do deals regardless of the investment outcome that the options create). The most recent vehicle, GS Capital Partners VI, closed with $20 billion in committed capital, $11 billion from institutional/high net worth investors and $9 billion from Goldman Sachs and its employees. That breaks down to a 55:45 split, much too rich a contribution from the GS side in order for them to play the games detailed in Even With Clawbacks, the House Always Wins in Private Equity Funds. Thus BoomBustBloggers should take note that GS Capital Partners VI is the current primary investment vehicle for Goldman Sachs to make large, privately negotiated equity investments in which they are serious about actually making investment gains in, versus churning and overpricing in the attempt to generate fees and bulge the bonus pool.

With this backgrounder in mind, be aware that GS Capital Partners rejected the Facebook deal as inappropriate for its clients (its clients being 45% Goldman employees and Goldman’s own balance sheet girded for longer term principal investment), in part due to valuation concerns. Mr. Friedman apparently has the very same valuation concerns that Reggie Middleton and BoomBustBlog hold.

Facebook:  Is it just a fad? Online social trends are completely unpredictable. If a new trend comes along that would start engaging people, then Facebook could become the old way of social networking just as quickly as it became the new way (if not quicker). It’s not as if it hasn’t happened already, ex. AOL, MySpace, Orkut and Hi5. Facebook does have an advantage that its predecessors didn’t in that they attempted to create barriers to entry for competitors with the “Facebook connect” api (application programming interface) that allows for sites across the web to authenticate through Facebooks user community rather than have a user type in repetitive login usernames and passwords. While this is an advantage in that it offers some barrier and is quite popular, it is not an insurmountable barrier for if the tide changes, all users need to do is enter one more username and password combo to switch over to another platform.

A high profile IPO commanding a premium valuation before the trend fades away is the best way to create excess proceeds from retail investors. We don’t believe that the Goldman Sach’s investment materialized to meet Facebook’s opex or capex requirements. The whole idea behind the investment was to set a ground floor for a “knock ‘em out of the ballpark” valuation in the eventuality of IPO and put Goldman Sachs as a front runner candidate to manage IPO. An IPO of that order would mean that Goldman has a chance to collect significant investment banking fees which typically range between 4-5% of the size of a flotation and to take part in windfall profits during a (successful) IPO.



Despite having given its clients just a week to decide to invest $2m as a minimum investment (word has it that due to demand, the effective minimum was $5 million) and given the dearth of available information about Facebook’s operations and financial condition, Goldman Sachs was reportedly able to close the deal a day early. The overwhelming investor response amounting to several billions of dollars for just a $1.5bn stake sale is a clear sign of investor fascination with Facebook, or a testament to the marketing fortitude of Goldman Sachs. The truth most likely lay somewhere in between.

Given the dearth of financial information under scenario one, we have estimated FB revenues based on subscribers growth and average revenue per user, and have assumed constant profit margin.

...To put the amount of optimism used in our analysis in perspective, there are 6,892,839,222 people in the world according to the US Census Bureau’s World Clock. Facebook currently claims 9% of that world population. Take into consideration a material percentage of that population are elderly or very young, infirm, illiterate, poverty stricken or located in remote rural areas and do not have iPhones and Androids, broadband connected computers and Facebook accounts, and may not have these things for some time, if ever. For the extremely optimistic benefit of the doubt, let’s assume that all children down to the age of infancy, the infirm, the illiterate and the Australian outback settlers all are frequent or likely Facebook users. Even with this assumption, Facebook will have to hit 65% of today’s total (as in the ENTIRE) world population (not factoring in population growth/shrinkage) by c.2020 to justify anything approaching a $50B valuation – and that’s assuming they captured 65% of every single man, woman and child in the world along the way – not 65% of those who have access to an internet connected computer.

Thus, it is highly unlikely one can legitimately factor in the type of growth needed to justify the current Goldman $50B valuation – particularly when you consider that Facebook’s growth is already slowing!


I make this point in an attempt to illustrate the absurdity of the valuation presented to investors as a once in a lifetime opportunity that you have to make a $2-5 million valuation decision on in a couple of days without audited financials. You may be able to make some money, but the chances are greater that you will trail the average ROR or outright lose a bunch of money than it is you will hit that grand slam. Those Goldman clients would have been better off investing in BoomBustBlog!

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Last modified on Monday, 11 July 2011 11:00