Microsoft's $500 million offer for 5 percent stake in Facebook makes good business sense: Analysts

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According to sources close to the development, Microsoft is willing to buy a stake in Facebook at a premium in order to halt the march of Internet search giant Google Inc's. expansion into social networking sites.

Facebook has grown at a phemonenal rate ever since it was launched three years ago, originally for college students, and has been drawing at least 200,000 new users every day, attracting advertisers that want to target users of a particular age or gender.

According to a report by the Wall Street Journal, talks between Microsoft and Facebook are still preliminary and rival Google has also expressed interest. Facebook had rejected a $900 million buyout offer from Yahoo! last year, expressing its desire to remain independent. Following its rejection, Yahoo! is now testing a new social service called "Mash" and recently struck a deal to deliver ads in England and Ireland to the social network Bebo.

The present investment discussions by Facebook are part of its effort to help expand its current payroll of roughly 300 employees and finance other parts of its ambitious expansion plans.

According to people close to the development, a handful of financial players including venture capitalists, hedge funds and private equity firms are also in the race to pick up a stake.

Representatives from Facebook, Microsoft and Google all declined to comment on the present talks.

Market analysts claim that Microsoft's premium offer price makes Facebook more valuable than the venerable Wall Street Journal (WSJ) for which media mogul Rupert Murdoch has offered $5 billion.

The WSJ with daily US sales of 1.7 million, is second to USA Today in circulation, and has won 33 Pulitzer Prizes, fourth behind the New York Times, Washington Post and Los Angeles Times.

The newspaper's website has 931,000 loyal online subscribers and the number is growing every minute.

Known for its detailed reporting and respected for its authoritative commentary, in financial and political circles, the WSJ is regarded as a must-read title, so much so that it has earned the nickname of the "business bible."

Microsoft's offer also makes Facebook more valuable than the popular video-sharing website YouTube which Google acquired last year for $1.65 billion or internet phone firm Skype for which eBay shelled out $2.6 billion.

So is the exorbitant price worth it? Richard Greenfield, a Pali Research analyst says yes.

Although Facebook may be unable to achieve its commercial potential, yet, "There may be competitive reasons to be connected to this asset beyond what the specific valuation is today," Greenfield said. "You may be paying a premium to keep others out," he added.

According to Greenfield, the lack of a track record for Facebook might actually be driving the price up. "Trying to delineate a value today of what was a new industry five years ago is challenging right now," Greenfield said.

Microsoft, which has an advertising agreement with Facebook in the United States, may want to lock up the site as a source of revenue and keep it away from Google, the most-used search engine. According to EMarketer Inc., the US ad spending on social-networking Web sites will double to $900 million this year, with Facebook and MySpace websites grabbing three quarters of that amount.

"Because people spend so much of their time online, because they're engaging deeply in Facebook, the value of advertising in that space could be very high," said Charlene Li, an analyst at Cambridge-based Forrester Research Inc. "You don't have that level of emotional engagement with Microsoft."

According to J. Nicholas Hoover, senior editor of informationweek.com, acquisition of Facebook stake will open up endless possibilities for Microsoft.

"The possibilities are endless…Microsoft can create applications to run on Facebook's F8 platform...Live Messenger for Facebook...Live Calendar for Facebook...Microsoft's Popfly mash-up tool already works with Facebook and Microsoft has a Facebook Developer Toolkit for Visual Studio," Hoover said.

Microsoft can also "create interoperable ties between Facebook and Windows Live Spaces or even SharePoint," Hoover said, adding, "Open social networks may be the future, and Microsoft doesn't seem to be getting much if any traction with Windows Live Spaces just yet. Why not give it a boost by opening Live Spaces users up to a huge group of people with whom to connect?"

Microsoft can also explore how to exploit the wealth of personal information that users plug into their Facebook profile pages, Hoover said, noting how Facebook has transformed itself into a distribution platform for software applications built by outside companies – widgets that can be accessed through Facebook and possibly used to sell goods and services.

Most importantly, through the acquisition, Microsoft, which already has a deal to syndicate ads at Facebook through 2011, can lock into the social networking site's millions of users as advertising customers in perpetuity, Hoover said.

"[Microsoft is] behind [in the social networking space] and I think they're slowly making more aggressive steps to build some relationships," said Jim Yin, an analyst at Standard & Poor's in New York. "Facebook is one of the hottest properties and it makes good business sense."

According to Forrester Research analyst Josh Bernoff, by building its own computing platform, Facebook has emerged as more a threat to Microsoft and investing in Facebook is one way for Microsoft to hedge its bets.

The Times also noted that there might also be personal reasons why Facebook would want to align itself with Microsoft. According to the Times, Facebook founder Zuckerberg has a personal friendship with Ray Ozzie, Microsoft's chief software architect and one of the people stepping in for Bill Gates, the co-founder who is giving up his day-to-day responsibilities at the company.

Also, Jim Breyer, a managing partner at the venture capital firm of Accel Partners and one of three Facebook board members, was an investor in Groove Networks, Ozzie's company, which Microsoft purchased in 2005.

But it does not mean that Google is out of the race. "Google would love to keep it out of the hands of Microsoft or at least drive up the price," Bernoff said.

"Google aims to find, organize, and display the world's information," RBC Capital Markets analyst Jordan Rohan said in a report.

"Facebook's goal is to map out those connections," and so the two complement each other with "little overlap,” he added.

According to market analysts, Microsoft, Google and Yahoo! Inc are all rushing to make sure they are not left out of the online social networking market. In August last year, Google struck a deal to provide search and advertising features to MySpace. Yahoo, owner of most-visited US internet site, forged an agreement this month to sell video and banner ads for Bebo Inc., owner of the most-popular social Web site in the UK.

Facebook was founded in 2004 by Harvard University dropout Mark Zuckerberg as a way for friends to maintain online profiles and exchange messages, including photos and videos. In May, Facebook began letting independent developers and companies to create features like games, photo-sharing tools and music players that run in Facebook. Facebook now has more than 8,000 registered developers and according to Li, "We have this situation where every developer worth his salt here in Silicon Valley seems to be working on a Facebook application."

Facebook is full of activities, from the goofy, like "biting" friends with a virtual vampire, to the more utilitarian, like seeing what parties and events Facebook friends are attending. There are more than 4,000 third-party applications on Facebook, Li said.

U.S. visitors to the privately held Facebook more than doubled to 33.7 million in August from a year earlier, making it the 14th most popular site, according to ComScore Inc. in Reston, Virginia. In comparison, visitors to Murdoch-controlled News Corp.'s MySpace, the biggest social- networking site, increased 23 percent to 68.4 million during the same period.

However, Facebook received 6.5 million unique visitors in August, compared with MySpace's 6.4 million, according to Nielsen/NetRatings.

Facebook's investors include Peter Thiel's Founders Fund and venture-capital firms Accel Partners, Greylock Partners and Meritech Capital Partners. In December, Thiel said Facebook might be worth $8 billion or more.

With more than $100 million in annual revenue, Facebook is believed to be a prime candidate for an initial public offering of stock next year or in 2009.