• by Ashkan Karbasfrooshan , Op-Ed Contributor, March 19, 2012

By suing Facebook for patent infringement, Yahoo is either seeking a cash settlement or some form of equity in pre-IPO Facebook, as it did in Google by way of the AltaVista patents it inherited when it bought Overture (who’d acquired AltaVista).

Seeing how Microsoft's $45 billion offer is a thing of the past, and Yahoo revenues have fallen from $7 billion to $5 billion from 2008 to 2011, maybe new CEO Scott Thompson’s lawsuit is a veiled attempt to force Facebook to ultimately buy Yahoo

If anybody fears Facebook these days, it’s Google.  Theoretically, Google may be inclined to acquire Yahoo now that Yahoo’s Facebook-killing patent arsenal is out in the open.  Mind you, antitrust issues over the combined entity’s search market share would squash that deal.

Microsoft and Yahoo have a patent-sharing deal, and it’s likely that Redmond is maneuvering to allow Facebook to use those patents. But something tells me Yahoo would have planned for that.

From a Financial Engineering Perspective, This Makes Sense

In 2011, Yahoo earned $1 billion in profits on $5 billion of revenues.  With a market cap of $18 billion, that is a price-to-earnings (P/E) of 18X and a price-to-sales (P/S) of 4X.

Meanwhile, Facebook’s IPO prospectus revealed $1 billion of profits on $3.7 billion in revenues.  By aiming for a market cap of $100 billion, Facebook is effectively seeking a 25X P/S and a 100X P/E ratio. 

In laymen terms, these ratios capture how much investors are willing to bid for every $1 of sales or earnings, with a higher ratio reflecting higher growth rates and investor bullishness.

To put things into perspective, Google and Yahoo command a 5X and 4X P/S ratio and a 21X and 18X P/E ratio respectively.

As the new poster child for the Internet, Facebook is commanding much higher ratios.

Could Facebook Afford Yahoo?

Companies buy one another with cash, debt or shares.  Facebook doesn’t have enough cash to make a purchase, but assuming it were interested, it can use its sought-after shares.

As such, even if Facebook bought Yahoo for $25 billion in shares, a 25% dilution may be worth it and help Facebook overall.

For one, a combined income statement suggests $2 billion in profits off $8.7 billion in revenues.  While Facebook’s P/S and P/E’s ratios are much higher than Google’s and Yahoo’s, it could be argued that the new combined entity’s ratios would not dramatically fall.

Facebook’s Value is Wildly Speculative

Facebook’s rising valuation has come from sales of limited stock on secondary markets.  With liquidity, it’s likely the stock will fall, although most individual and institutional investors will view Facebook as the new bellwether of the Internet and buy it, maintaining the lofty valuation and possibly pushing it further.

But if Facebook doesn’t increase revenues and profits, the fundamentals would pull the stock down.

Facebook’s Problem

Facebook’s main problem is low CPMs, which may go up, but I don’t buy it.  Google had low CPCs early on, but the eCPM that those CPCs generated were high from the get-go. 

Facebook’s booming ad inventory supply almost ensures that CPMs stay down, and the decision to include multiple ad impressions per page will haunt it: if it reduces the number of impressions it will simply reduce revenue but not necessarily increase performance, since Facebook’s social media advertising is far less promising than Google’s paid search results are.

This doesn’t mean that Facebook won’t evolve into a profit machine (it already is), but Mark Zuckerberg’s brain trust ought to be asking themselves: “What can we do to increase CPMs?”

Facebook’s Video Opportunity

According to comScore:

On Facebook, 43 million unique users generate 239 million video views, spending an average of 23 minutes per month.

On Yahoo, 60 million unique users generate 721 million views, spending an average of 68 minutes per month.

Assuming zero duplication (unlikely), that’s 103 million unique and over 1 billion video streams for the combo, cementing Facehook as the #2 in video in the U.S. after YouTube (150 million unique, 16 billion views and 420 minutes per month).

Google Has Evolved From Tech to Media Company…

A few years ago, people asked “is Google a media or tech company”?  Its acquisition of Zagat put any doubt to rest.

… Facebook Will, Too

It’s possible that Facebook’s mindset is where Google’s was in 2006: technology will solve all problems and advertisers will follow.  But as Google evolved into a media firm to woo Fortune 500 advertisers, Facebook will, too, in order to increase ad revenues and CPMs. And as Google bankrolled $200 million worth of exclusive content, Facebook will, too.

Programming Is the Future

The clutter online and in video is greater than ever.  Yahoo adds licensed and created content, as well as programming chops.  The value has gone from aggregation to curation; the big opportunity tomorrow comes through programming.

What about Facebook Credits and Payments?

While Facebook Credits’ payment system might prove revolutionary, its larger source of revenue will likely remain advertising.

But what about payments?

Meet Yahoo CEO Scott Thompson, Who Used To Run Paypal

Thompson ran Paypal before and has already hinted at taking Yahoo down that path.

Suddenly, this isn’t so crazy, is it?