“With all these winners, who will the losers be? The average investor, of course, who will get left holding the bag when, someday, Wall Street realizes the firm’s financial performance doesn’t live up to its hyped valuation.”

January 4, 2011, 9:00 pm

Friends With Benefits



William D. CohanWilliam D. Cohan on Wall Street and Main Street


Can Goldman Sachs, the profit-seeking missile of high finance, really make money by investing $450 million in Facebook, at a vertigo-inducing price that values the social-networking company at $50 billion?

On first blush, the answer would appear to be no. After all, in May 2009, the company was valued at $10 billion. Last August, Facebook was valued at $27 billion and now it’s $50 billion — for a company with a reported $2 billion in revenue and negligible profits. If General Electric, with 2010 revenue of around $150 billion, traded at a similar multiple of revenue, it would be worth $3.75 trillion instead of $200 billion. Facebook is now considered to be worth more than Time Warner, DuPont and Goldman’s rival Morgan Stanley.

Just last week, Facebook’s shares were said to be trading on a private-market exchange at a valuation of $42.4 billion. Thanks to Goldman’s imprimatur, Facebook’s value increased 20 percent virtually overnight. Can Goldman really expect to squeeze more water from this stone?

Sadly, yes.

To understand why, we have to go to the heart of the many problems in the way the Wall Street cartel does business, despite the promised reforms of the Dodd-Frank law. With Goldman’s investment in Facebook, we have a front-row seat to the process by which Wall Street creates and inflates financial bubbles.

This bout of hysteria involves not only Facebook but other Internet companies including Twitter, the gaming site Zynga, the social buying site Groupon and LinkedIn, another social networking site. The valuation of these companies has soared in the past two years, leading some to worry that the American people bailed out Wall Street so that we could relive the Internet Bubble of 1999.

Despite the high price of its investment, Goldman sees in Facebook a business bonanza, a nearly perfect nugget of investment-banking opportunities. First, Goldman’s cost of capital is close to zero — as a bank holding company, it can borrow from the Federal Reserve at negligible interest rates — so any capital gain it makes on its venture in Facebook will be sheer profit. Second, Goldman has almost certainly locked up the role of lead manager of the inevitable Facebook initial public offering.

Fees for underwriting public offerings are generally about 7 percent of the value of the stock sold. Facebook could easily sell $2 billion of stock or more, generating fees to Goldman and the other underwriters of at least $140 million. The other benefit for Goldman in leading the public offering — aside from major bragging rights — is that it can use its marketing, sales and distribution muscle to make sure the value of Facebook at the time of the offering exceeds the $50 billion valuation at which Goldman invested.

Goldman has also won from Facebook the right to offer an additional $1.5 billion of the company’s stock to its private-wealth clients. According to The Times, Goldman will be creating a “special purpose vehicle” to sell the stock to its wealthy clients and then will charge them a 4 percent initial fee plus 5 percent of any profits. While on paper it seems that these high rollers would be foolish to invest in Facebook at such a lofty valuation, they will still most certainly feel increased loyalty to Goldman for making such an exclusive opportunity available to them. On top of it all, there is the increased likelihood that Goldman will get to manage a good portion of the $12 billion fortune belonging to Mark Zuckerberg, Facebook’s founder, for yet more fees.

If Goldman does take all these roles at once — investor, salesman, money manager, I.P.O. underwriter — it would certainly raise the ugly specter of conflicts of interest. But probably not to Goldman executives, who have always prided themselves on being able to “manage” through such situations. (In fairness, there’s likely no investment-banking firm on the planet that would not eagerly take Goldman’s place in this scheme, if offered the chance.)

Even though Facebook is reported to have little need for Goldman’s money, having Goldman validate Facebook’s exponential increase in value gives Mr. Zuckerberg the ultimate Silicon Valley street cred, far more than he got from having Hollywood make a movie about him or from becoming the youngest billionaire on the planet.

With all these winners, who will the losers be? The average investor, of course, who will get left holding the bag when, someday, Wall Street realizes the firm’s financial performance doesn’t live up to its hyped valuation.

4 Responses

  1. […] This post was mentioned on Twitter by Mahfuz. Mahfuz said: FACEBOOK HYPE: SAME GAME WE HAVE SEEN BEFORE: http://t.co/DMWtZsm http://dlvr.it/CmbYv […]

  2. Facebook has its place, but putting sensitive personal information on it is not smart. From what I understand, since the government has your personal info, and the government is in on the Ponzi scheme; they already have your personal info.

    I know a former employee of Wachovia who told me that all personal information was shared with BofA. All the banks share the info even if it is illegal. Since when did they start doing things legally? http://www.challengingforeclosure.com Sirak@challengingforeclosure.com

  3. Neil,
    Did the “investors” suffer so much during the Great Depression too? You know, maybe we should do more for them. I think all of us homeowners/ex-homeowners/homeless people should stop only being concerned about where their kids can wake up and go to school from, where to sleep at night, rest when they get off of work and where to eat breakfast, luch, and dinner.
    I’m mean come on there’s “investors” out there that are expecting that high return so they can take that vacation in Cancun in the spring, payoff their mistresses’ ferrari, add a second story to their summer home in the Hamptons and build that new Casino on the Indian reservation they just bought at foreclosure.

    Haven’t you heard what the average public service pensions are? Like only $100,000 a year, how do can they expect to retire at 45 and live comfortably the rest of their lives on just that? Sacrifices must be made for our hardworking government employees who slave all day long over a bench, in an air conditioned room, wearing a black robe, swinging a gavel and arguing with people who refuse to pay their lender that never lent them money, telling them that they have to get out of their homes then so somebody else can pay. They could probably have claims against us for enforcing involuntary servitude in violation of the 13th Amendment slavery prohibition.


  4. Yes. GS will have access to millions upon millions of peoples’ personal information for their banking strategies.

    You could not pay me to join FB.

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