Digital: Do The Numbers Support The Investment?

News Corp.'s $580 million bet on MySpace has turned into a $10 billion-plus proposition that set the stage for Microsoft's $250 million for 1.6% of Facebook. That sum suggests a $15 billion valuation for the 3-year-old private social network that barely breaks even on $150 million in annual revenues.

They are high-profile examples of how media values are being redefined by best-case digital projections rather than historical multiples of cash flow and other balance sheet specifics. Still, digital interactivity is no Internet bubble--already generating billions of dollars in new revenues for so-called and new media companies, from Walt Dsney to Google.

But placing big bets on digital enterprises supported by strong trends rather than substantiated with real numbers has been the business of venture capitalists rather than public companies. Big media companies, from Viacom and NBC Universal to Google and Yahoo, continue to buy all or parts of niche digital product and service providers to enhance their existing businesses with sparse financial metrics. Overall, billions are being invested in a new generation of interactive media concerns that have yet to prove their worth.



The investments are good as long as the hunches pan out. Indeed, a critical factor in media valuations is the management of risk: The risk of investing in new media enterprises with no financial track record (only intangible, important connections), and the risk of investing in the transformation of old media operations, whose valuations are becoming fluid in light of changing economics. For many of the traditional media conglomerates, their investment value is not so much in their existing financial fundamentals, but the radical change that hinges on the sale, spinoff or radical restructuring of their core businesses.

While valuations can encompass projected assets sales, restructuring and other dramatic change, they generally are rooted in projected tangible financial performance--some of which is being skewed by emerging digital economics. In short, the valuation expectations and standards set by and for media-related companies will be in flux for the foreseeable future.

At a time when connections are everything, Facebook could begin producing the financial metrics historically used on Wall Street to justify valuations. After all, MySpace has mushroomed into a $1 billion annual business. With a valuation the same as Viacom and CBS combined, Facebook is in pursuit of essentially the same treasure: consumers for advertising dollars. But in the digital interactive world, huge premiums will be attached to target consumers, personalized information and transactions completed with service and product providers. They have been the more general underpinnings of broadcast, cable and print media for decades.

While media companies, advertisers and funders feel their way through the first phases of digital interactivity, it isn't clear how high the bar will be set for revenues, returns and valuations. Even with support from Microsoft's ad machine, it is unclear how Facebook will monetize its users in ways that will not be intrusive or change the social network's unique value proposition. Those all are big "ifs," similar to what MySpace and other online rivals face. But the fact that these unknowns are heavily weighing on valuations is challenging expectations for media investments, returns and performance to new levels.

For instance, Facebook's new valuation is rooted in the implications of global social networking, advertising and transactions barely understood or utilized. It is based on the advertising and commercial promise of its 50 million global, upscale young users spending record time online being outside the U.S. Absolutely key are the new forms of deeper, more intricate sanctioned Web communications shared by Facebook friends (messaging, writing on walls, nudges). Facebook founding CEO Mark Zuckerberg is exploring the target advertising and other Internet services wealth of his user base (growing by an estimated 200,000 people daily) by opening the platform to the ideas and applications of outside developers. That's an extraordinary entrepreneurial measure, now being embraced by other much bigger Web players.

Under such circumstances, no one knows what Facebook is worth. But because Microsoft has set a bar for its value (Microsoft founder Bill Gates is said to see much of his youthful spirit in Zuckerberg), expect other major companies to follow suit with financing and service support.

Another example of uncertain but seemingly soaring online value is Yahoo's 39% stake in the Chinese e-commerce giant Alibaba, which is valued at about $3.4 billion, or 150% more than when Yahoo acquired the stake a year ago. The fortuitous investment has enhanced Yahoo's own valuation well beyond Yahoo's balance sheet performance and worth, an estimated $6 for each $33 a share of Yahoo stock, thanks to a savvy investment by former CEO Terry Semel. The search engine, valued at about $9 billion, expects to raise $1.5 billion when it begins trading publicly in Hong Kong Nov. 6.

Or consider the case of Time Warner, whose long-languishing stock will be boosted by the confirmation of CEO Dick Parsons' successor Jeff Bewkes. His mandate will be to break up the company to better monetize its pieces. There is as much uncertainty with the further breakup and spinoff of Time Warner's new and old media assets, triggered by a change in corporate leadership.

Pali Capital analyst Richard Greenfield has declared AOL "less relevant" than ever as the social networking consumers of Facebook and MySpace (which are skewing older) rapidly move away from AOL's core email and instant messaging utilities. Efforts by Facebook and MySpace to embrace targeted innovative new forms of digital interactive advertising and transactions will upstage the general ad network strategy AOL is pursuing with a declining user base.(Greenfield cites Facebook's new digital flyers on which advertisers can relay and post their messages to the specific interests of specific users in specific geographic locations.) Time Warner runs a big risk of not developing branded, deep content sites to be leveraged off the online social networks it does not have. While Time Warner shareholders essentially are getting AOL for free with the company's stock trading at $18 a share, the magnitude of the Internet portal's stand-alone value no longer is a sure thing, given the quicksand base it plays on.

Indeed, Pali's Greenfield is among the increasing number of analysts who believe that simply selling off Time Warner assets, like AOL, will not automatically create new value for shareholders as the valuation of such assets are in flux. Just as damaging is the lack of an articulated strategy about the restructuring and management of core assets and operations to take advantage of the new digital interactive platform and rules of play.

Time Warner is hardly alone. Viacom suffers the same plight. Analysts say the underperformance of its stock and its overall valuation is tied to the uncertain structural digital health of its key television networks and other content operations.

What investors don't know about how a company's balance sheet will play in the digital marketplace can cut both ways. On the new media side, much of the investment isn't based on hard numbers, but blind faith.

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