Bubble or Bank for Web 2.0: Microsoft Friends Facebook for $240 million

In October, Microsoft bought a 1.6 percent stake in the social network Facebook (see right) causing a buzz reminiscent of the 90’s dot.com bubble. The international powerhouse Microsoft handed out $240 million for the tiny portion of Facebook valuing the site at $15 billion, the fifth most valuable Internet company after Google, Yahoo, Amazon, and eBay. With 50 million users and 200,000 joining daily, Facebook hosts a significant customer base on which to draw for companies like Microsoft. Microsoft’s investment is not the only one Facebook has received as two hedge funds also put in similar bids, which Facebook accepted according to articles in CNN. In all, the social network picked up $700 million dollars to put towards a badly needed structural overhaul and R&D for the future. However, Facebook’s revenue is one-tenth its $15 billion price tag, and the site produces no profits.

The parallels are glaring, but is this really the harbinger of another collapse? Some are calling the recent acquisition of Web 2.0 companies, like Skype and YouTube, Bubble 2.0. eBay acquired Skype in Sept of 2005, and Google bought YouTube.com for $1.65 billion in November of 2006, but to the trained eye there are distinct differences that should make everyone breathe a sigh of relief (see below right).

The inflated price tag of Facebook is partly the result of an online advertisement war (see below left) being waged by technological powerhouses Microsoft and Google. The investment in Facebook was a defensive maneuver on the part of Microsoft as Google has the upper hand in the online arena. Google already has advertisement deals with other social networks such as MySpace and even has its very own online meeting place called Ortuk. However, some experts like Matt Rosoff, an analyst specializing in Microsoft, believe that even though the deal was a good move, the price tag smells suspiciously of the 1990’s dot.com era. John C. Dvorak of PC Magazine echoes this sentiment calling a collapse “a sure thing.” On the other hand, a recent article in Business Week claims that once “beyond gut feelings, the comparison simply doesn’t stand up.”

The high values for Web 2.0 companies in addition to the skewed price to earnings ratios they enjoy are the cause for comparison to the 90’s e-commerce bubble. However, there are a few significant differences when comparing the two. First of all the business being acquired have active members and are not based on speculation. Internet based companies now have a model to make money by that is centered around advertising and not the idea of e-commerce. Secondly, the 90’s boom was fueled by IPO’s, money those companies never actually had. The acquisitions going on today are bought with cash reserves from well-established businesses. Another reason is a result of changes in the technological market. More than 70% of adults in American are online as opposed to 40% in less than ten years ago. Compounded with the fact that most of the new startup companies, or Web 2.0 companies, advertise themselves online instead of using costly television ads.

In light of this, I believe that there is justification for the price tag and no reason to be worried by a imagined looming bubble. With so many users already and more joining every day, Facebook is a massive potential advertising machine. Traffic is so high on social networking sites and other Web 2.0 applications that revenue from advertising would be more than significant. Microsoft needs this deal to increase its online presence in the face of a looming Internet war with Google. Blocking Google out and increasing advertisement presence is a significant move especially when the price tag only makes up less than a percent of the buying company’s value. In the end, the price tag remains a little excessive, but the scare of a bubble should be left in the 90’s.

Pay to Pollute: The Commerce of Carbon

In light of former Vice President Al Gore’s award winning campaign to battle global warming, the public has stumbled across a very inconvenient truth. In the past fifty years, greenhouse gas emissions have almost quadrupled from 1.6 billion to 6.5 billion tons. (See graph below right) This unprecedented growth of pollution over the past few decades is thought to be the main contributor behind global warming. In efforts to combat these rising levels of pollution, especially carbon emissions, many countries like Brazil, the United States, and most of the European Union have adopted emissions trading schemes that limit the amount of carbon and similar greenhouse gases produced by power plants or their industrial corporations. The process assigns monetary values to “carbon credits” which companies can buy or sell. This is designed to present an economic incentive for polluting less as companies that reduce emissions can sell excess carbon credits for cold hard cash. Though currently fraught with problems, with the right direction, carbon credits could be the currency that buys a better future.

In the United States, President George W. Bush’s Clear Skies initiative concentrates its efforts to reduce emissions of SO2 (sulfur dioxide), NOx (nitrous oxides), and mercury from power plants. (see graph below left) According to the White House, the act will emplace “a dynamic regulatory approach – emission caps and trading – that provides power plants with flexibility to reduce emissions in the least costly way.” The government “caps” the level of emissions allowed in the country and doles out allowances to individual companies via an auction. Certain levels have to be maintained and then reduced at predetermined deadlines. In the United States, Clear Skies calls for a reduction from 16.3 million tons of all emissions to 6.6 million tons by 2010 and then 4.7 million tons by 2018, a total reduction of 72%. Personally, I like the cap-and-trade model. It solves an environmental problem with an economic solution. The most basic laws of economics determine the best allocation of credits and ensure maximum efficiency in reducing pollution. Self-interest, not federal sanctions, motivates companies to be more environmentally friendly. In addition, the cap-and-trade method allows the government to take a hands-off approach. Instead of wasting billions of dollars on litigation and manpower, the government simply has to set the limits and distribute the allowances. To contrast directly, the EPA declares that the cap-and-trade program has “achieved reductions at two-thirds the cost of… the same reductions” using the previous system of regulation and penalty over the past ten years.

This glowing picture of emission trading systems founded on solid economics seems too good to be true, and according to the Sierra Club, it is just that. In contrast with the previous Clean Air Act, “Clear Skies” loose[ns] the cap on NOx pollution to… an increase of 68 percent” and SO2 pollution 225 percent from Clean Air. Since this information comes from studies performed by the U.S Environmental Protection Agency, it is difficult to refute. Related to the high caps in the Clear Skies proposal, the United States government, as well as the EU’s Emissions Trading Scheme and the UN’s Clean Development Mechanism, has come under fire due to recent claims from Professor Catrinus Jepma of the University of Amsterdam that these systems have failed to provide “the excepted benefits due to a collapse in the price of carbon credits.”

In short, governments setting limits overestimated. The high emission caps have led to a surplus of carbon credits in the market, and in accordance with economic modeling, the price of the carbon emissions has dropped dramatically. All the way back in May of last year, it was revealed that countries using the European Trading Scheme, think Clear Skies for the EU, had set caps too high “resulting in fewer firms than expected having to buy credits.” This led to a drop of the price of carbon credits from thirty Euros to less than five. If the price of credits drops too low, the incentive to reduce pollution drops next to nothing as reducing emissions will result in insignificant profits when sold on the market. This in turn directly influences companies’ decisions to research new ways to reduce emissions more efficiently. However, this is not a failure of the economic system but a failure of the governments’ ineffectual limits, as seen in the success of the Brazilian model. By setting limits too high, the government does not constrain the firms enough and the whole process fails to achieve market equilibrium.

As an economist, I believe in the “invisible hand” of the free market. Under the proper constraints, I think that the cap-and-trade system will lead to the most efficient use of resources to reduce pollution. The cash incentive of selling surplus credits should encourage industries with already low levels of emissions to invest in R&D to reduce their emissions even further and even provides the capital to do so. Alternatively, the blow to the wallet buying more credits entails should deter companies with high emissions from cutting corners when reducing their carbon footprint. Ultimately, the only way to motivate big business is to provide an incentive that they understand, money. Though the problems surrounding carbon credits are significant right now, I feel the modeling of the system is sound with only the deficiencies of the governments setting limits holding it back. With proper revisions, the country can get right back on the track towards saving the environment.