Facebook's Rich Valuation Based On E-Payments That May Never Come

Last Updated May 25, 2010 6:00 AM EDT

Last spring, Russian investment group Digital Sky Technologies purchased $200 million of Facebook's preferred stock, putting Facebook's value in the neighborhood of $10 billion. Now it's prepared to invest again. But DST's CEO may be waiting for a payoff that isn't coming.

While lower in valuation than Microsoft's (MSFT) investment in 2007, the DST deal has been roundly criticized as profligate. But according to Reuters, the company may be preparing to build on its 2% stake despite overpaying the first time around. Why? E-payments: Facebook's phantom killer product.

According to comments this week from DST's CEO Yuri Milner, Facebook's disruptive potential in the electronic payments market -- which is now ruled by contenders like PayPal (EBAY), Zong, Nokia-backed (NOK) Obopay and Amazon (AMZN) -- is what drew him to Facebook last year, and again this year. Reports the Telegraph:

"Many people thought Facebook at a $10bn valuation at the bottom of the market was expensive," [Milner] said. "But our thesis is to find the best companies in their categories and invest in them. The better companies that we look at tend to be expensive... Anybody can make a mistake," he said. "But this is a vision I am convinced [of]. My vision is that Facebook will change a lot of things about the world, particularly e-commerce payments."
The Telegraph goes on to say that Milner has lofty expectations of the virtual gaming and virtual goods markets that have flourished on Facebook, and thinks the mainstream consumer's junk-shopping will soon go entirely virtual. The Telegraph says:
[Milner] acknowledges that it is a vast amount of money to spend on things that only have a virtual existence, but says people are already spending billions of pounds on other "unnecessary" goods, such as ties and fancy furniture.
Whether or not people stop buying tangible junk and move to virtual junk, everyone can agree that electronic payments (and more broadly, e-commerce) will only increase in time. But so far, Facebook has stood largely on the sidelines of these burgeoning markets. As I wrote in January, Facebook Payment Operations had a belated, rocky start, and only just recently has the Facebook Credit system become operational. Now that it is, the social network is gearing up to receive a 30% cut from the revenue of every platform that uses it -- including Zynga, makers of cash-cows FarmVille and MafiaWars, which just signed a five-year contract with the big blue network.

Zynga makes a ton of money -- about $50 million a month in revenue, according to recent valuations -- and Facebook will do well slicing off a portion. But it's nothing compared to the volume of total mobile and Web payments, even today; never mind the predicted 40-fold increase in mobile data usage coming by 2015. At present, Facebook doesn't have a mobile payments solution, and has no way for users to send money to each other or to third party retailers on the Web. Right now, Facebook Credits can only buy you virtual stuff, as on Farmville.

Meanwhile, the competition are busy adding to their massive market-share in developing countries (Obopay), building out great user interfaces for mobile phones (PayPal) and making deals with ad publishers and cell carriers (ala Boku). By contrast, Facebook still has a long way to go in building its payments team; just check out the dozens of positions it has yet to fill.

Once CEO Mark Zuckerberg gets his payment operation in full swing, it will have the benefit of 100 million American users and nearly 100,000 websites that already use Facebook Connect. But a secure payments system has to be one of the most difficult and expensive departments any tech giant can endeavor to build from scratch, since it has to be overbuilt and extensively tested; mistakes could cost the service any veneer of security and privacy and render it dead.

Considering Facebook's latest privacy issues, its payments system will have to endure even more internal scrutiny and engineering than it normally would. By the time it's ready for primetime, e-commerce outlets looking for a Web or mobile payments partner may have already signed with competitors, making Facebook's valuation even more grossly inflated than presently thought.