First of all, David: The word is VALUATION, not evaluation. KTHX.
Secondly, EVERY SINGLE COMPANY IN THE WORLD that has shares that trade is valued by taking the last share traded and multiplying by the number of shares outstanding. It's just the DEFINITION of valuation. It's TAUTOLOGICAL.
The whole section "Minority investment evaluations aren’t real" is so economically bizarre and incorrect that I don't even know where to start. It's like you wrote a blog post arguing that it is incorrect to refer to a 5' tall boy as 5' tall because he's often sitting down. Every single day every single public company in the world is valued by the last share traded, usually for a tiny fraction of the company.
Finally, to the main point. Facebook has certainly figured out how to make money off of 500,000,000 users. And as they optimize, they will make a lot more money. When they figure out how to make another DIME off of every user, they will instantly be making another $50,000,000 a year... in pure profit. How much profit will 37signals make if you figure out how to make another dime off of every customer? Eh David? Facebook works on the theory that when you have a lot of people, you don't have to make as much per person, because the amount of money you make is the number of customers times the amount of money you make off of each one. Again, that pesky multiplication.
It's weird, it's like in Chicago they don't have multiplication or something.
2. Publicly traded companies have instant liquidity on many more shares, which makes using "last share sold" an meaningful metric.
3. When only 3% of the money a company is supposedly worth has been moved around, it's a poor indicator of what the other 97% would go for.
4. They haven't figured out how to make much profit yet. And it's still questionable whether they will. MySpace supposedly also just needed to turn on the faucet, but apparently the water ran out before they got to it.
5. Oh, and New York smells. (take that!)
3. Also not correct. When entire companies are bought and sold that had a previous market in the shares, the price for the entire company is usually a PREMIUM ON the the market valuation. "PREMIUM ON" means MORE THAN. Somewhere in Chicago, I understand that there is one market of some sort, I think they trade corn and pig bellies, surely SOMEONE there can explain it to you...
4. Also, just not true. They are very profitable and their profit is almost certainly growing at a rate that will make their valuation reasonable.
3. Again, these premiums are based on outstanding shares traded under the transparency of the public stock market. See Secondary Suckers for a nice take on the perils of the secondary market: http://www.homethinking.com/brontemedia/2010/09/17/secondary...
4. Do you have their P&L handy to back that up? If the valuation was so wonderful and they were raking in the profits, then taking series E funding three months ago doesn't make much sense.
You may not agree on the worth of the album or of the shares, and nobody is forcing you to buy either one. That some people do consider it a good price is enough to result in a market price for both, on the basis of which many decisions are made.
And yes, this happens now and then for ordinary, exchange-traded companies. Usually, it results in the exchange suspending trading for the company for a bit. Sometimes, it requires someone to call B.S. In an ordinary, regulated market, one or the other of those actions restores sense, gets the price back somewhere within shouting distance of reasonable.
Not sure what phenomenon you're referring to in your second paragraph.
Presumably subprime mortgage backed securities are the exception that proves the rule...
For instance - Tonight we got an exception and are allowed to stay out till 11pm, would imply that there exists a rule that forbids them staying out that late. Hence the exception proves the rule.
The spread reflects the willingness of firms to compete as market makers. More firms competing means a smaller spread.
The spread also reflects the risk associated with the market maker holding inventory. The more perceived risk, the bigger the spread.
That's pretty close to the 0.000000001% that put our $100B valuation on paper: http://37signals.com/svn/posts/1941-press-release-37signals-...
But hey, you better snatch these shares up quickly. It's rare that you get a chance to a clear shot at a company where "profit is almost certainly growing at a rate that will make their valuation reasonable". How much can I get you down for, Joel?
Valuing Facebook just by the market price on Sharespost is like predicting the outcome of an election when only 1% of the votes have been counted. Maybe those votes are a representative sampling, maybe not.
I'm inclined to think not, because you have to be an accredited investor, ie already wealthy, to buy pre-IPO shares. Facebook's investors are there for the potential upside and are more comfortable with risk than Joe Blow saving for retirement or his kid's college education.
So Sharespost prices will be higher because (PROB_FB_DIES * NEG_UTILITY_FORME_IF_IT_DOES) will be less negative for millionaires than for the middle-class people or conservative mutual fund managers who will buy most of Facebook's equity when the company goes public.
You "only" need $1 million in net assets (minus the house due to recent law I believe) to be an accredited investor. I would really be surprised if Joel didn't have at least that much.
I think the simple summary of your point is this: Things are worth what people are willing to pay for them, not what other people think they should be willing to pay for them.
Facebook is worth $26 billion. That doesn't mean that buying it at a valuation of $26 billion is a good investment. Worth and my estimation of what it will be worth in the future two are different things.
I agree with this, but there is a difference between the market being willing to pay $26 billion for a company, and minority investors being willing to pay $26 billion/0.03. Only the former establishes the actual* value.
A decent estimate would include the expected future worth, whether it is based on expert analysis or a market's expectations. I don't think any estimate here could be categorized as what "it will be worth in the future".
Anyway, the primary reason that your point 3 is true is because of basic supply and demand. It is harder to buy all the shares than to buy a few. When it's perceived there's a very small number of shares available--I don't know if this is true, but it does seem like investors are clamoring to invest in Facebook--share price will be higher than if that were not the case. In particular, perceived scarcity can share prices artificially high. The idea of getting a slice of the pie before someone else does was a big factor in the dot-com bubble, for instance.
When a VC invests in a company, they're looking for a big exit. Essentially, they're trying to predict how much the company might IPO or get acquired for. A public investor is trying to predict the rise in future profits of the company. The difference in motivation matters when you consider a hypothetical.
Suppose the company is guaranteed to have stagnant or falling profits. Does that discourage the VC? Not necessarily. They don't care about whether the company can make money. They care about whether they can keep building perceived value in the eyes of anyone who would want to acquire. A public investor, however, would not put their money in that company (at least not for long).
Therefore, I think David's main point is sound - VC's are more likely to over-value your company than the market is. We also know this to be true because of what happened in the early 2000's.
Wily investors always look for meaningful volumes before taking big jumps/declines in share prices seriously.
One of the easiest ways to ramp a stock (apart from getting your journalist buddy to write a puff piece) is to continually lift the offer for small volumes.
In the early days of computerized trading it was quite common for even quite liquid stocks to be suspended limit up/down because of programming bugs.
But by Joel's logic, the market has 'spoken' and these companies are now worth 10% more/less than 30 seconds prior, when in fact all that has happened is some faulty code just ripped through the book on minimal volumes.
The point is that 'true' valuations are validated by significant volumes. Hence Google's valuation is real. Depending on your viewpoint, the size of the recent transactions in FB may or may not be material - and I think this is the point that David was making.
You need some amount of liquidity to make a meaningful valuation. Lack of liquidity leads to price volatility. Think May 6 flash crash.
Oh, and New York smells. (take that!)
Two of my heroes dragging discourse on hacker news into the toilet. What's the world coming to?
Is the problem that they're sitting there in a city without any other Internet industry, stewing in their own witty ideas, listening only to the adoring comments they get from the groupies?
.. is a often genuine criticism of 37s here on HN. Probably part of the reason the joke was missed.
Warning: Prolonged exposure to HN comment sections may blunt your sense of humor, too.
Do they have some history or it's just impulsive?
On this one, I am with David. Joel pretty much negates his point about using something battle tested and mainstream in the end when he mentions using some proprietary language for his product, which translates to a couple of mainstream languages. I don't really see the point of cross-compiling to multiple languages. The work and time invested in maintaining the proprietary language can be better invested on other critical activities. If language interoperability is an issue, thrift or message queues is there to the rescue.
Why he would use some fancy stuff when he himself is advocating using mainstream stuff is beyond me. I sure would be betting on ruby being more robust than whatever he is using in-house (preposterous claim; I have no ideas what they have in-house)
IMO the only valid complain about Ruby was lack of good unicode support at the time post was written.
I do remember some post from 37 signals commenting about Joel's taking investment; not sure if it was David or someone else though.
A very thin line divides frank and honest speech and rude and arrogant statements. Most of the internet celebs sit on the fence and cross it every now and then - Linus Torvalds (Open BSD devs are a bunch of masturbating monkeys), Zed Shaw(Rails is a ghetto) etc etc.
That being said, there always is a take-away as these people are one of the most hardworking and talented people in the industry but the sad thing is it makes it difficult for people not familiar with their style to neglect the firework and just consume the good parts(not that it would matter to any of them).
He's a New Yorker, it's in his DNA.
HackerNews: battlebots for geeks who can't build an ashtray without a makerbot
I was also surprised that it didn't really address the question of whether or not you (37S, dhh) are "stewing in their own witty ideas, listening only to the adoring comments they get from the groupies"
Do you have any thoughts on the "bubble-ness" of Chicago. Think it's a totally invalid point?
What's laughable is Joel's implicit assumption that the majority of 37s clients are, apparently, Chicagoans. How charmingly pre-internet of him.
In the real world, markets cannot be absolutely efficient or wholly
inefficient. It might be reasonable to see markets as essentially a
mixture of both, wherein daily decisions and events cannot always be
reflected immediately into a market. If all participants were to believe
that the market is efficient, no one would seek extraordinary profits,
which is the force that keeps the wheels of the market turning.
In the age of information technology (IT), however, markets all over the
world are gaining greater efficiency. IT allows for a more effective,
faster means to disseminate information, and electronic trading allows
for prices to adjust more quickly to news entering the market. However,
while the pace at which we receive information and make transactions
quickens, IT also restricts the time it takes to verify the information
used to make a trade. Thus, IT may inadvertently result in less
efficiency if the quality of the information we use no longer allows us
to make profit-generating decisions.
Price is simply a function of supply and demand. It's not customary to use a fire sale price as the sole basis of a company's valuation.
Nonetheless, Joel's post is quite funny.
Also, "meanningful" is an excellent example of Muphry's Law.
Indeed. And Pets.com was worth $100 million on the day of its IPO. And tulip bulbs were worth more than a man's annual salary in 1637. And that house down the street was worth a million dollars last year. Someone paid for those, too.
You don't have to have a different definition of "valuation" to see that a small sample of the most eager investors in the private market doesn't guarantee a reliable estimate of value.
Company valuations are messier than tulip bulb valuations though. With tulip bulb valuations you are saying that since someone will pay x the bulb is valued at x. With company valuations you are saying that since someone will buy 1/n of the company for x then the company is worth n*x. This makes sense because people really want a piece of facebook and valuations do a great job of setting that price. But the price is also used to determine how much the entire company will go for, which is how the number is often thought of.
As long as the valuation goes up and you have the opportunity to sell for a net gain then it is a good investment. DHH's thoughts here are important beacause they call attention to a valuation bubble. I think the main controversy lies in his creative use of words.
Not "someone", but THE MARKET ... when you buy a piece of Facebook, but won't be able to sell at least at the same price, then you're the loser ;)
When multiple losers gather and start buying stupid shit with no value to THE MARKET, that's called a BUBBLE, that will burst sooner or later.
The trick for estimating if "the valuation goes up" is to see if that company actually provides value (i.e. actual profits, since that's the only goal of a company) ... and in that light, DHH's opinion makes a lot of sense.
This is unexamined Econ 101 dogma. See the other posts on intrinsic value.
Everyone who invests should know that market value does not necessarily predict intrinsic value, and it becomes more problematic when there's illiquidity, and when only a small fraction of the company is being bought and sold. These are basics, going back to Ben Graham's famous book on value investing, and probably much further back than that.
Even if liquidity and size didn't matter, it's still a basic error to go by last share traded and claim that that represents the actual value of the company.
Is the problem that they're sitting there in a city
without any other Internet industry
Their linkbait really grates on me as well (though I happen to agree with this post's conclusion, if not the methods), but I think it's pretty unfair to say that they misunderstand all the basics of business. They seem to be doing pretty well for a shop their size. In fact, I'd say there's a good chance they're doing better than Fog Creek. Maybe misunderstanding the absolute perversion of what too often passes for "business basics" in Silicon Valley isn't such a bad thing.
First of all, he's from Denmark – he just lives in Chicago. Secondly, ever heard of a little startup called Groupon? They're from Chicago and I'm assuming they have a few people there that excel at multiplication.
The location of 37signals has nothing to do with it, and you're clouding an otherwise clear and well articulated set of points with the asinine notion of "no one outside the valley understand business".
This would have been a valid argument 2 years ago if Facebook was trading at this valuation, however Facebook has a reasonable valuation given their rapid revenue growth. They may surpass $200 million this year and their user base is still about to double (yes, to beyond 1 billion users).
They haven't even begun to open up the revenue faucet. 37signals should stick to providing advice to "lean startups" who want to build small businesses.
The fact that they have gotten to the point where other companies are able to build majorly successful (Zynga) businesses based on their platform, and the fact that they have become ubiquitous with many business' marketing and online presence speaks for its self.
The fact that the total amount of time spent online is greater for those on Facebook than Google (including Youtube) is also important. http://news.cnet.com/8301-1023_3-20016046-93.html
But what is more important is Facebook's pursuit of pushing the envelope and being willing to innovate and lead as the online landscape changes.
The posts above which mentions that people were saying the same thing about MySpace having the user base and then not being able to monetize is like comparing apples to rotten tomatoes. MySpace was not a technology company, Facebook is. MySpace was primarily a media company with little to offer technologically (see: http://paulgraham.com/yahoo.html), Facebook is building a social web that has deep horizontal integration with the Social Graph Protocol, mobile communication, and is actively trying to optimize it's infrastructure for both scalability and user experience. Look as far back to their decision to go with AJAX and not base everything strictly on page loads (as MySpace did), or as recent as their open sourced internal projects... (I don't think MySpace ever worked on any HipHop PHP or Cassandra)
Facebook is in it with the right mindset, to be the leader and game changer in the "social web," and with both the value and quantity of data they are constantly amassing I wouldn't be surprised to see them on par with Google in a few years.
Also, as they grow they can continue to optimize and decrease costs on their end... I'd say they have both a big faucet to open and probably a few leaks they could plug as well, the combination of which makes for a large valuation to be expected.
It's always easier to look at something we don't quite fully understand from the outside (not many people understood the true value of those little text ads on Google until later) and then make blanket assumptions on valuations based on other companies that were inflated but not even on the same playing field as the company being discussed.
How will Facebook change its platform to convert its hundreds of millions of users, who signed up for a free party, into billions of dollars per year without spoiling the party? No one likes getting invited to a party with their friends only to find that the beer isn't free after 11:30, or worse, they've been tricked into attending an MLM meeting. If Facebook could convert eyeballs to dollars the way Google can, there was no reason not to do so when they had 50 million users, or 100 million, or 200 million... It hasn't been done, though, because it would spoil the party and stop that lovely flow of VC money.
I am just gobsmacked that, within just a few years of the US housing market bubble popping and the financial empires getting caught with their pants down, you would continue to support the speculators' fantasy of pre-IPO tech valuations. These types of valuations aren't just irresponsible or insane, they're scams! The consumers have no money or credit left, so the easy money is going to come from gullible investors.
Also, Chicago has lots of smart people, and I agree with you that FB is well positioned to make lots of money.
They've massively invested in infrastructure, which has certainly lowered profits. They could very well start benefiting from this as soon as next year.
Without information, though, it's all speculation.
Right - that's the point. The valuations are not based on actual profits or profit potentials but rather on speculation/hype, which means bubble, and when a bubble bursts, it ends up hurting the entire community.
Obviously, startup valuation is not a science. BUT when valuations are based on wild projections (such as FB will be be more profitable than Google), then someone must call it out.
It isn't 66$ per user. It is 33billion/expected number of total users over the lifetime of facebook.
So if you throw in rough estimates of 2 billion facebook users and give them a decade of profiting from an average user...3$ per year per user.
Does anybody else see a problem in that?
A company's valuation can certainly take into account growth potential, but when it assumes massive growth and leaves no margin bad things happen. Risk is much higher since any faltering of the company would need to be adjusted for in stock price almost instantly. If a normal company sees slower than expected growth the stock may fall a little. If an overenthusiatically future valued company sees slower than expected growth the stock may tumble by huge margins (because it's tied to the company's size 10 years from now, not today). Worse yet, if there's no margin remaining in stock price it'll be forced to remain stagnant for a very long time. This is bad for investors and bad for the company (because the use of stock as employee compensation is less potent).
Facebook may well achieve the numbers outlined above. But let's not kid ourselves. People were doing the same back of the envelope calculations for MySpace when it first started to get big. I see nothing wrong with a judicious use of common sense and caution in this case.
Also you can't link the 33billion to expected. 33billion is their "valuation" now with 500M active users. There's a certain expectation that your valuation should go up as users increase.
Personally I think the per-user deal is kind of a red-herring. Revenues and Profits are the only things that really matter. Users are just a one (good) dataset for estimating growth - but hardly the only one.
Right. Because the Chinese and Indian Peasantry is definitely going to be on FB.
It's not like facebook could invent a yearly membership fee or start selling t-shirts or such...
Well, they could, but I doubt more than ~20% of their audience would actually pay.
I always used to think I was a 'leech' user of TripAdvisor, until I worked there.
If so, they've gotten a dime from you.
3 ads per page, each ad selling at a $0.10 CPM.
But CPC, well I've never clicked on an ad on Facebook in my entire life.
Otherwise, even google would be out of business.
You literally type into Google "I have this problem" and get a bunch of ads solving that problem. It is practically the holy grail of advertising. Now consider that it is a catch all for personal and corporate questions, it is a cash cow. It is perfectly acceptable to google something at your job, click on a link, and buy a $15,000 system.
Facebook might know a lot about you, but they don't know what you are looking for at any given moment. Add on top that most people are spending their time on personal relationships, and it isn't the same even if they get more impressions. I can't log into Facebook from work and say "who has 5" diameter pipe?" and expect a response, but if I google that I find a vendor and place a multi thousand dollar order.
Also the market on Facebook is somewhat inverted. The "best" customers are generally on their the least. The most frequent people are college students - mostly broke at that. If you aren't advertising clothes, personal electronics, or local bars I don't see the draw.
Google ads work when there is so-called "purchase intent": I know I want a new waffle maker, so I search for it.
Facebook ads work when there is demographic correlation: I just got engaged, and I might not know that I now need a waffle maker, but a Facebook ad can target me and tell me that I should be adding a waffle maker to my wedding registry.
Different kids of targeting, both extremely powerful.
And seriously. Waffle maker. It's the gift that keeps on giving.
...and many other Chicago-based internet companies
But what I think the 37signals post is addressing is how directly tied this valuation is (or isn't) to the company's intrinsic value. price-to-earnings, a guess at its margins, durable competitive advantage etc etc. In that sense, is facebook truely worth $33B? That's a different question than what's its current valuation. Its subjective, to be sure, but its still fundamentally different.
Its a private company. I doubt many outside the company know its financials. Information scarcity leads to pricing inefficiency. For all we know, speculators might be driving up the price to cash out sooner.
Another point I mentioned before: Everyone is incentivised to see the valuations go higher. The VC's, employees with shares, the founding team, etc. They can cherry pick talent from the competition with such valuations. Since I don't think you can short SecondMarket stock, there's no way to bring negative information into the market to keep prices rational.
To your last point, facebook has certainly figured out how to make money off its current users. But it has radically changed the underlying user-conventions to get there. It started out as a college-yearbook and photo storing site with no profit-motive. In order to become profitable, its iterated on that simple concept with such a pace that the majority of users have yet to catch on with how things have changed beyond photosharing and posting on friends walls. The majority of people have no idea what is being tracked. For them to squeeze out further revenue, it follows that more fundamental changes must take place to get there.
Whats one thing that could absolutely destroy facebook? Overnight? If they started making public which users were viewing which profiles, and with what frequency. That could kill it pretty easily, I think. Of course, they would never do it, but I think if a terrible scandal or crime occurs, involving sensitive user data, and people are compromised in such a manner, that would be a problem for facebook.A billion dollar company shouldn't be so easy to kill.
> "The city posted a sign," means that an employee of the local government (but not the geographic location or all of its residents) posted a sign
I think you are talking past one another. He's saying that he does not think that their valuation is merited. You are saying that his assertion makes no sense because valuation is, by it's nature, defined by the current trading price.
You are I think technically correct, but the market isn't always perfect in judging the value of something, and I think he is saying that this is one of those cases.
"The whole section "Minority investment evaluations aren’t real" is so economically bizarre and incorrect that I don't even know where to start."
I don't think that's so bizarre to say. If there is huge demand for something and only a very very limited supply, then doesn't it stand to reason that price will go up more than it would have otherwise if there was more supply?
Facebook is not (yet) public, which is a massive factor relative to the calculation of its book valuation. Presumably, at least on the surface, all of this facebook hype of late would indicate that what used to be a closely-held entity is quickly becoming ripe for the IPO market. What the actual valuation is (or will be) cannot be determined until the free market goes to work on it.
But then again, speculation, anticipation, and fear . . . these have all been attributed to major market fluctuations, crashes, overnight millionaires . . .
Assume they want to continue growing. Growing both the number of total users and the number of places they grab the users' attention (mobile is the next natural play). Of course they would continue raising money and not worry about profit margins right now as they are still driving money back into the company's growth.
There are two factors that influence your 'multiplier theory' given their advertising model. Number of users and the amount of attention you have from those users. They still have a lot of potential upward growth in both areas.
If facebook made a billionish dollars this year on ad revenue - they could double it with twice as many users. Double it again with twice as much user attention from being a core part of the mobile web. They are still growing their ad platform, so that is another multiplier.
Remember a sucker is born every min and Elevation Partners has been a sucker over and over in many investments. Would you spend $6 per dollar of Apple revenue or $25 for a dollar of Facebook? Case closed.
Disregarding the technical usage of the word valuation in investing, I see three ways of interpreting the terms in the argument here. The price of Facebook is 33B, simply extrapolating from the price of tiny percentages of Facebook.
The value is related to the price people are willing to pay, but is actually unknown and only exists as a prediction of future cash flows.
The worth is a more nebulous concept and related to how much Facebook improves the world.
It seems like spolsky is talking about the price, and dhh is talking about the value, and making illusions to the worth.
-The last executed price times shares outstanding is market cap. Valuation is dcf or guideline; there's a big difference between capitalization and valuation.
-Sharespost can not be considered liquid as all of its securities are governed purely by regulation D and are by definition on hard to borrow
-Facebook will not continue its current exponential rate of revenue growth for the standard 5 year assumption DCF
(jk, but maybe not)
Its most avid core user base will graduate with their faggy liberal arts degrees, find out they can't earn for shit, advertising revenues will peak and decline, at which point Facebook will file a timely SEC S-1, followed by a record oversubscribed ipo mostly bought by parent(sponsors) of said faggy liberal arts graduates, then get basket shorted down to 50% of offering price. IB, instl. trading desks, and VC will already have gotten rich long before this; everyone else loses. Same deal with carbon/ECX emissions futures.
-NY owns Chicago; Chicago is the guy on the merc floor shouting hundreds of open outcry bids while one trading desk at 200 west st. takes every bet against him using one single macro on Rediplus. (jk, respect to all veteran floor traders)
-I'm sure everyone will decide their bets based on their own risk-reward/due diligence anyways. Nothing we say to each other will have a huge effect; in the end, the bids and offers we provide will do all the talking for us. That's why the market exists so let the games begin.
>It's like you wrote a blog post arguing that it is >incorrect to refer to a 5' tall boy as 5' tall because >he's often sitting down.
It's not like that at all. It's more like comparing a 5' tall boy with a 5' tall light pole and deciding that valuation is based on height alone.
>It's weird, it's like in Chicago they don't have multiplication or something.
Yeah, good point.
So you would agree with the valuation of Slide or Ning a few years ago? Maybe. Would you now? No. Valuation of private companies is not a science but an art. That's startup 101 stuff. Do you really call Sharepost a market most investors would call credible? Please.
Perhaps a little more humble thoughtfulness, rather than indignant ignorance, would do you some good.
This sounds like a bunch of privileged people arguing about something that that doesn't make a damn bit of difference to what's really needed in this world.
I thought I was going to learn something. But now I just feel a little ashamed that I read any of it all.
As opposed to being located in a circle-jerk of similar minded companies and VCs, responsible for the first internet boom?
"The whole section "Minority investment evaluations aren’t real" is so economically bizarre and incorrect that I don't even know where to start. It's like you wrote a blog post arguing that it is incorrect to refer to a 5' tall boy as 5' tall because he's often sitting down."
If he's ALWAYS sitting down, then it's accurate to argue he's not really 5' tall ―not for any practical purpose, that is.
But not only "minority valuations" are not real, but majority valuations are not real either. Valuations are based on guesses, feelings, estimations and some facts thrown in for good measure. A declaration of fact, they are not. Some time they are even complete BS.
"Finally, to the main point. Facebook has certainly figured out how to make money off of 500,000,000 users. And as they optimize, they will make a lot more money. When they figure out how to make another DIME off of every user, they will instantly be making another $50,000,000 a year... in pure profit. How much profit will 37signals make if you figure out how to make another dime off of every customer? Eh David?"
And how useful is David's products to customers, eh Joel? How possible it is that they jump ship en masse when something trendier comes along, compared to Facebook? That is, which business is based on a solid offering, and which on virtual smoke and manure?
Yahoo could once milk 500,000,000 users too. Nowadays, not so much.
"Facebook works on the theory that when you have a lot of people, you don't have to make as much per person, because the amount of money you make is the number of customers times the amount of money you make off of each one. Again, that pesky multiplication."
Yes, many a business failure was based on that theory. It's the old, "we lose money on each product, but we'll make it up on volume" idea, adjusted as "we make a tiny fraction of money from each user, providing no real benefit or substance, and he can jump ship tomorrow like he did on several of our predecessors, from Frienster to MySpace, but we'll make it up on volume".
"It's weird, it's like in Chicago they don't have multiplication or something."
Most likely it's like NY has no manners...
But the real question is, should someone even partially responsible for Visual Basic even be allowed to talk about tech?
It would make Facebook the 79th largest company in the US, and 226th in the world. It would be right behind the likes of DuPont, Dow, eBay, Metlife, Time Warner, and Target, and right ahead of the likes of DirecTV, Lockheed Martin, Texas Instruments, Dell, Fedex, and Nike.
I wouldn't buy their stock at any valuation, there are much more solid ways of investing than speculating on something that already feels over valued. And if I would want more risk then I'd rather put my money in start-ups than facebook.
The next bubble is here, and it will go the same way as the previous ones.
Remember what netscape was supposed to be worth.
edit: sorry, that 'majority' was meant to be 'major'.
I mean this in the sense of odds--was the valuation wrong because the odds of success were really so slim, or are we calling the die roll of a hard six inevitable after the fact?
I bring this up because I had a similar feeling to what you describe about Google around its second stock offering, but it has done extraordinarily well since then. I second guess these judgments because in hindsight everything seems inevitable.
As for netscape, yes, in part it was a lost (or destroyed, more likely) opportunity, but at the same time even if they had continued to be successful their valuation at the time was right up there with far future science fiction.
Go to http://www.facebook.com/ads and take a look.
You can target ads at "all doctors under 30 in the chicago area that went to a ivy league school". This type of targeting can lead to huge CPMs.
One example of where they could go: they are one cookie away from a significant branding ad platform.
Another idea: advertise on keywords in activity streams. Tie this to the branding ad network above.
Update: Not clear why this is getting downvoted. These are two huge opportunities for Facebook that could easily justify big multiples. And people said the same thing about Google (no serious business model) before it went public.
I can't make soup of it. What's their intention long term, everything seems to be in anticipation of what they're really going to do.
In all the time that I used facebook (haven't used it in months) I had a very hard time figuring out how they were making money on or off me.
It can't be the ads I never clicked and it wasn't the subscription fee I never paid.
* ads in margin
* special paid for groups
* sponsored likes
(these are discussed in Kirkpatricks book of Facebook - and here: http://www.quora.com/Facebook-1/What-is-the-revenue-distribu...)
Additionally, Facebook has just launched Facebook Credits. Zynga (revenues $600M+) is their launch partner. Facebook gets 30% of their spend.
I do not think they are struggling to monetize.
Maybe the zynga deal is a prelude to that.
It would make good sense to do that, facebook is the closest we've got to a verified ID on the net. The issues to contend with would then of course be hacked accounts and such but that's not different from other payment systems.
Another elegant definition of liquidity is the probability that the next trade is executed at a price equal to the last one. A market may be considered deeply liquid if there are ready and willing buyers and sellers in large quantities.
The liquidity of a product can be measured as how often it is bought and sold; this is known as volume."
I don't think any sane investor would consider private shares of Facebook "plenty" liquid. The volume of Facebook trading is so low that when a large trade of it does occur, as in this additional investment that valued it at $33b, the price jumps wildly and it makes news.
As per the secondary market, Sharespost shows the last contract traded on their system being over 3 weeks ago, and that there are only 3 people willing to sell and 5 people willing to buy right now. Those are pathetic numbers.
Granted, shares are not entirely illiquid either. You could sell your shares... but it's a necessity that the more you want to sell, the lower your price is going to have to be to attract enough buyers.
This is a strawman. If they wanted to make money right now they would. But they also observed many examples of turning-the-faucet-on gone wrong, especially with the whole privacy issues, that they are moving very carefully in that space. But they will make a lot of money if they decide to start.
The truth is really that they do not know how to monetize themselves effectively
This time next year they will have 12months of ads + platform revenue to show off. Their business model hasn't been complete up until now.
That is why they opened and sanctioned the secondary market, because of employee pressure and because they had to buy time before going public.
Besides companies prefer to remain private, esp because of the amount of overhead being public adds (esp after Sarbanes Oxley). The role of CEO completely changes when you are a public company.
If anything the reluctance to go public is a good thing, since it means that Facebook are thinking it through and establishing themselves - not making a dash for cash.
Google was also very reluctant to go public, but the SEC and their own employees forced the issue.
This is going to be one hell of an IPO.
I don't take David's flawed 'they wouldn't raise money if they were making good revenue' as a valid statement. The revenue they make is all profit - there is no middle man or hidden expenses. They have operating costs which are sizeable, but it as they grow and mature their business and revenue - their profit will grow.
* Marc Andreessen
* Jim Breyer
* Peter Thiel
because they are some of the directors on the Facebook board, and I think they know their stuff.
I've got a dot bomb crash, real estate bubbles and sub-prime mortgages that say otherwise.
No offence to any of them personally, and I'm not about to argue FB's actual valuation, but they all have a vested interest in making us all believe that it is as high as possible.
They are the last people one should be looking at when making an investment decision.
Petty arguments aside...
Something being logically fallacious does not make it false, all it is saying is that the premise [that top business minds that have successfully done this sort of thing in the past] does not prove the conclusion [that they know what they are doing/ will be successful now].
Of course it doesn't prove it, no more than knowing someone is Jewish male proves that they are circumcised, it just provides a strong suggestion as to the outcome.
HOWEVER, one thing that has been bugging me is the thought, espoused by 37signals, that not generating a large profit as a business is a bad thing. We're forgetting that these businesses that don't make huge profits are still employing large amounts of people, creating new jobs every day, and giving back to the community in many ways. Facebook has over 1000 employees. Granted they may not be making 33bil in profits (or even revenue), but that's pretty cool that they were able to create 1000 new jobs that didn't exist before, while also improving the lives of many people who use the service--eg, helping people keep in touch with friends and loved ones, helping people find old friends, etc. If they break even for the rest of the existence of the business, they're still doing pretty damn well IMO.
Presumably Facebook's investors are hoping for more than to merely "break even".
Sure Facebook is a decently designed site that makes sharing your photos, videos, comments, links, etc. easy. But that’s not hard to replicate (the backend scaling parts are hard, but invisible to the end user). When people find the new social network that all the cool kids are using, they’ll flock to it and abandon Facebook in an instant, leaving shareholders dazed and confused. I doubt Facebook will die as quick & horrible a death as MySpace (in addition to being more fad-driven, MySpace was also centered around a fad-ish industry and had horrible usability), but it will die a similar death.
Google on the other hand has developed revolutionary technologies that other companies find nearly impossible to find the talent & resources necessary to replicate and improve upon. They provide a real, unique, non-fad value proposition to the end user. Same with Amazon, Apple and many other established tech companies.
Facebook investors' problem is, will they be able to get a return on their money before a new social network becomes the trendier place to be.
Google's revenue in 2004 was $3.1B:
Facebook's revenue for 2010 is rumored between $1.2B and $2B:
VC investment rounds and secondary market transactions are probably not the best way to price a company, but they seem to be in the ballpark.
And a valuation at, what, 33x revs (on a good day)? I'm sorry, but gambling that hard on a web company on the basis of "potential" profits is not good business (I don't know whether it's a Silicon Valley thing or not), if you know, they can be bothered to monetise it before the next website du jour comes along.
YouTube was "valued" at $1.6bn, and has really struggled to make money. I'm not denying that it wont pay off for Google in the long run, but when Facebook floats, you think that investors will stick around if they struggle to monetise and fail to bring profits and revenues to a 1/5 or a 1/10 of valuation in 4/5 years?
Not true. Sure they have raised $1B themselves, but a lot of stock has changed hands on the secondary market. Facebook sanctioned employees being able to sell stock up to a certain amount, in lieu of going public (employee pressure was part of what prompted Google to go public).
2. "In other words, the evaluation is resting on the flawed assumption that Facebook could actually ever get 33 times as much money to change hands if they wanted to. There’s just no way, no how that’s happening right now. If it could, they’d IPO tomorrow."
Again not true. When you IPO you don't float 100% of your shares. In the case of Facebook, an IPO may not even see 10% of the company listed - ie. not a lot more than what is already being traded in secondary markets.
Most listed companies do not exchange 100% of their stock - not even close. By this reckoning then, no company in the world has a real valuation because at no time is all of their stock available for purchase. The author needs to go to Google Finance and lookup any of the Fortune 100 and see for himself that most have a lot of stock outstanding or not listed.
3. "If the supposed billion dollars Facebook is allegedly pulling in this year was happening at anywhere a decent margin, they wouldn’t have needed a series E round of $120 million from Elevation Partners just three months ago."
You should have read the link you posted, because the story is that Elevation bought $120M of stock from private holders. ie. Facebook didn't raise that money. The last money they raised was $200M (on $10B) from Digital Sky in May of 09
(btw if you did read the story at the link you referenced, the 4th paragraph mentions that Facebook revenue for '09 was $700-800M, not the 200 'best guess, being generous' that you work on).
But anyway, the recent (cheap) money they raised went into CAPEX (building datacenters to lower your overheads) and cashing out some stock holders for a very high valuation for non-voting stock.
Facebook is still at the growth stage so every dollar is (wisely) re-invested in the company in ways that will improve the bottom line. $100M is a drop compared to the cost of building datacenters (the new Google datacenter in Iceland cost 250M - without servers).
Having their own datacenters will reduce their infrastructure costs over time. While it is a lot of money - it will pay itself off within a few years because atm they are leasing space and bandwidth. Not a bad use of what is 1% of their company.
4. "But let’s be charitable. Let’s imagine that Facebook miraculously made $200 million this year — a 20% margin. (I don’t think that’s true, otherwise why take another $120 million from Elevation Partners, but hey, let your imagination roam). That would put Facebook’s P/E at some 165."
How about we Get Real(tm) and say $1.1B this year, and that is before they start booking platform revenue from Facebook credits, which will be 30% of everything Zynga et al make (and Zynga made over $500M+ in '09). $700+ in 99, $1.1B+ this year, and at least an extra billion in the first year of Facebook credits. Not bad.
Each time they double revenue you can halve the PE - which is why it is so high atm.
"No outrageous profits after seven years and half a billion users"
They are profitable, and on a trajectory that will see them reach ridiculous numbers. See the more sane and informed discussion about Facebook revenue projetions and the business model here:
(if you are actually interested in learning why Facebook is valued so highly, what the business model is and where it is going - check this link, the conversation took place earlier today and it will save me re-hashing a lot of the points here)
Facebook has reached every corner of the world in short time. We can all agree that their ads suck - yet even with this shitty advertising, which is mostly for Russian brides, they have managed to hit a cool $1B - without even trying. Imagine if they had some real ad technology behind that site. They will do something that Google has failed to do, that is, have two sources of revenue. 1. the ads. 2. the platform - both of these are billion dollar businesses.
What is more depressing than just how mis-informed and terrible this article is? The number of fans in the comments who eat up every word and cheer them on.
Does Facebook approve the sell price? If so then it's likely biased up.
They also have to make sure that they remain within the 500-shareholder rule, which would otherwise force them to go public (which is what happen to Google).
* '09 spent $400 on $700M of revenue ($300M profit)
* profitable since Q2 of 09
* one of the only social networks to ever reach profitability
* 55% of US retailers present on Facebook
* 20% of global social network ad revenues
* 550,000 approved apps, 1M developers
* 20% of users have logged into another site using connect
* Zynga revenue is over $40M a month. Up to $10M of that goes to Facebook for advertising, while Facebook then take 30% of what Zynga make through Facebook revenue. So Zynga first pay Facebook to get the users, then pay Facebook again when they make money from those users. Great model.
(both reports source from SEC filings and other sources)
FWIW, I believe that $50-100B is where Facebook's market cap will plateau. More than Amazon, about half of Google. I'm not at all in agreement with dhh on this one.
Joel is talking about market value.
What Joel is saying is "dude, you don't understand value. Value is what people are willing to pay for. If someone - just one person - is willing to pay $100 for a millionth of a broken piece of crap, then that broken piece of crap is worth a hundred million dollars, your opinion of it notwithstanding".
He's right. Technically.
But David does not care about market value (although he tries to attack it and picturing it as not real). David is talking about intrinsic value; he's saying: "this thing has 500 million users, and that's amazing. But they don't make much money out of all those users, let alone any profit. So if we try to estimate the present value by actualizing future cash flows, we find the real price should be... well, not much".
He's also right. And I think he's fundamentally right.
During the housing bubble, some people (Peter Schiff for example, or the heroes of The Big Short) argued that the real value of housing was a multiple of rent (10-15 times rent), and that anything above that was crazy.
At the time, they were wrong -- they were very wrong; the value of a house was the market price, not the "intrinsic" price. The value of anything is always the market price.
But then suddenly there is no market. The bubble bursts and nobody's buying.
In that situation, if you're selling you don't have many options; but if you're buying how do you calculate a price at which you'd be willing to buy, and a price at which you may convince a seller to sell?
- - -
In a sellers' market (Joel's market) prices are fair because people accept them. If everyone wants a piece of Facebook at any price, just because they have to have it, then, well, the value of Facebook is infinite. It's not 33 billion dollars: it's the whole amount of dollars in the universe, plus one.
But this situation never lasts. There has to be a time when Facebook will be out of fashion, and someone will have to ask what is the intrinsic value of this thing.
The intrinsic value is hard to compute because you need to actually know how the company makes money, you need to understand its operations, its cost structure, strategy, etc. That's hard work for a public company; it's almost impossible, from the outside, for a private company.
But one thing is certain: the intrinsic value of Facebook is not infinite.
And then and there, David has a point.
Facebook has gotten increasingly annoying to use lately and the reason is changes are being made that benefit the company's ability to make money, not the interests of the users. I remember a time when all my friends were on myspace and suddenly everyone switched to facebook. The reason was facebook loaded instantly and you didn't get spammed by bots trying to make money off you. These two things are becoming increasingly less true of facebook today and I can feel the attempts to make money on facebook becoming more intrusive and more insulting of my intelligence.
Also as Cory Doctorow has pointed out, the inherent of value of a social network decreases over time the longer you use it [http://craphound.com/?p=1961]
It's possible for facebook to become a real success but they need to figure out the difference between creating value and making money and not try to make money by destroying value. That is never a self-sustaining strategy.
If facebook goes out of business (unlikely, but want to cover every scenario), you win 10k.
If facebook is purchased outright by another company we take that as a fair valuation and pay the bet out in the same was as an IPO+30 days price.
If facebook is still private 5 years from now it's a push (don't want this to be open ended forever).
We take the difference any multiply it by your "stake" (10k/33B) and the bet pays off.
So, for example let's say facebook IPOs 335 days from today (so IPO+30 = 1 year). With the 5% interest that puts us at 34.7B as the comparison valuation.
So if FB is worth 0 on that day, you win 10k.
If FB is worth 20B, you win about 4.5k.
If FB is worth exactly 34.7 it's a push.
If FB is worth 40B, I win about about 1.6k.
If FB is worth 50B, I win about about 4.6k.
1) Make sense?
2) So you in?
Sure. As long as you do the same.
In fact, I think this would be a great little business. Allow people to place long-term bets with money on the line on predefined, objective results. Then hold the cash in escrow until the resolution day.
Is it worth $33b today? Not sure. Could it be worth $200b someday? Could Facebook be bigger than Microsoft? Bigger than Google? Bigger than Exxon? Maybe. I can't think of any other company for which "maybe" is a reasonable answer.
That's why investors value it so highly.
They're featured in an article entitled "Defacebook"
. Disbelief that FB is worth that much, or
. ad-hominem attacks one way or the other, or
. Technical discussions on whether there's sufficient liquidity to get a real 'price'.
When I look at what facebook has done, and the absolute fucking mountain of data they sit on, FAR better quality than Google's in my opinion, If I were on the board, I would be thinking "brilliant job executing on growth, guys. I'm deeply excited to see you make all this pay once you're not running around putting out massive fires all the time."
It's not going to be rocket science to make it pay, and pay, and pay...
Taking another slice: I'd bet my entire (comparatively very small) net worth that the board would unanimously vote down a $33B cash buyout offer right now. There's just no way you guys think that FB has topped out; it hasn't really even gotten going when you think of a complete, end-to-end business model yet.
Job offers happily accepted. : ).
Facebook didn't raise a Series E from Elevation Partners; that firm purchased secondary shares.
Seriously, you can't ride in on a high horse of fact and reality and then get the basic tenets of your argument so wrong.
Facebook is probably more overvalued by this because so little Facebook stock is up for sale, but it's not really fair to make this argument about Facebook without mentioning that the same issue exists for all publicly traded companies as well (save a company where all of its stock is changing hands every day).
The flip side of all this valuation talk (you know, DHH had me at 'evaluation' hahahaha. that's priceless.) is that if you were to attempt to "buy" Apple, it would cost you a lot more than $267B... maybe even a trillion dollars. Does that make them worth more or less than their valuation? Don't get me wrong, there are dynamics here, it's not a static calculation.
That is, successfully running a neighborhood cheese shop requires different skills - and attention to different metrics - than successfully running GE.
One is not 'better' or 'worse' than the other. They are simply different.
37signals is a small business. This is not a knock against them.
The knock against them is that they readily forget (ignore?) this when they point fingers at other, large corporations for operating differently from them.
My take is that Facebook is transitioning into a phase where they will try to monetize their user base by a large factor. Vector of their approach is widely speculated in media (they'll take on google, they'll make phone, they'll do this, they'll do that). The fact is that we don't know for sure what and where will they hit, but certain fact is they must hit somewhere. Speculation is fed with that fact.
Google had a 5 year span before it hit Adsense. Amazon was in the gutter for quite some time... I really see no point in this article from the arguments perspective.
I see a point in subjective matter where one who understands only a traditional commerce model (http://en.wikipedia.org/wiki/Commerce) would have trouble with speculative nature of business like this. From the tone of the post it looks like the message here is the messanger's emotions rather than fundamental aspect of point being made (since there isn't any to begin with).
I often use the tallest building in the world as a reference for the value of 1.5 Billion dollars. So FB is worth about 20 of these.
The sad thing is hearing how much our government loosely throws around a billion dollars. 50-Billion here, 100-Billion there... No biggie.
It is important to point out however, this a valuation does not make. Liquidity is not part of the equation.
As a toy example, imagine a company that could be worth $3, $30, or $300 each with equal probability. The logical valuation of this company is $111. A risk tolerant investor would pay $11.1 for 10% of the company.
Now imagine you have a 3x liquidation preference. If the company liquidates for less than 3 times your investment, then you get it all and the suckers holding common stock get nothing. How much will you pay for 10% of the company in this situation?
Well, if the company exits at $3 or $30 then you’ll get all of it, and if it exits at $300 then you get $30. The total expected value is ($3 + $30 + $30)/3 = $21. That’s almost twice what you’d pay if didn’t have liquidity preference! Even though, with 3x liquidity preference, you’d pay $21 for 10% of the company, $210 is clearly a nonsense valuation for the company as a whole.
It's actually not at all uncommon for wildly profitable companies to take an additional round so they can continue to ramp up at accelerative rates.
It will be interesting to see how hundreds of millions of people seeing a film (on- and off- cinema screen) – supposedly depicting shady roots of their favourite website – will react.
Most likely, with a "meh…" but let's wait and see.
In Japan Mixi got eclipsed by Gree when it came to making an IPO because Gree focused on games and selling virtual goods. Gree had way more profits and growth potential. They eventually opened up to social gaming but their profits are still strong. Ditto Mobage.
The way Zynga built on Facebook is similar to how MicroSoft and Intel took off of IBM. Facebook's valuation and growth potential would be astronomical if they owned a piece of social gaming instead of just providing infrastructure.
Basically, a lot of people DONT wanna be on facebook, they probably detest the very idea! But they ARE! As a business owner what else could you want? And would someone pay $33b to get 500 million+ users, Absolutely!
I love 37signals, as I'm sure most of us here do too, but this analysis on Facebook is completely haywire. I bet he would've said the same thing about Google's prospects back in 2000, just like that BW article.
This is simply not true. There are many reasons why a company may want to stay private.
True. But there are a billion reasons to be looking for an exit - all those VC investors are eventually going to want to close out their funds and get real money for their institutional clients. Not to mention all the employees.
Most of these shareholders are going to want to cash out in the next few years, and $200 million in profits won't go far towards making that happen. They've got to exit eventually, and $33 billion is a lot for a major company to pay for Facebook when they don't have a clear monetization strategy. I mean, that's twenty times bigger than the YouTube sale. So IPO it is.
I imagine a lot of the employees could and probably have cashed some shares out in previous rounds. I'm sure VCs are happy to wait for their IPO (they can probably raise funds just by saying they own Facebook stock)
The ad spend has to go somewhere.
The same thing will happen to Facebook with the open web. At least AOL had subscription revenue.