I hate to leap in with what seems like an ad-hominem attack on the 37 signals, but their utter and complete misunderstanding of all the basics of business is starting to grate on me, and I'm wondering if it has anything to do with Chicago. 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? How else could you explain just how far they seem to have drifted away from basic reality?
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.
"Secondly, EVERY SINGLE COMPANY IN THE WORLD that has shares that trade is valued by taking the last share traded and multiplied by the number of shares outstanding. It's just the DEFINITION of valuation. It's TAUTOLOGICAL."
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.
It should be immediately obvious that they're comparing intrinsic value vs market valuation, so no, it's not tautological at all.
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.
their utter and complete misunderstanding of all the basics of business is starting to grate on me
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.
I don't entirely disagree with your points here, but as someone who is from Chicago and spent many years helping to build a very successful Chicago-based business (Threadless), I take offense to the notion that David's misconceptions have something to do with Chicago.
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".
37signals is great at understanding the laws of small business, however arguing with those same laws doesn't always work when scale is involved.
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.
Seriously, Joel, Facebook just needs to "optimize" a bit and they'll be more profitable? Really? With a valuation of $33 billion, Facebook needs to make a bit more than a dime or two extra from their users. They need a ton of real dollars from each and every user or (more likely) dozens or hundreds of dollars from some users and nothing from the rest. How are they going to do that, exactly?
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.
There is a relevant difference between valuations derived from secondary markets and public markets. Investors in secondary markets rarely have clear understanding of real financials or the capital structure of the company. This is a good writeup: http://www.homethinking.com/brontemedia/2010/09/17/secondary...
Also, Chicago has lots of smart people, and I agree with you that FB is well positioned to make lots of money.
What does Chicago have to do with FB valuation? KTHX.
DHH makes a good point though - what are FB's profits/profit projections? No one knows. Assuming its $200M, how the hell can FB be worth $33B? That's all...
I agree mostly, but it is true that in private equity, it's not always taken for granted that you can take a small stake's buy-in price and multiply it out to get a valuation. It depends on why that investor bought in, what the prospects for similar investors are, etc. It's taken with much bigger grains of salt than the standard (share price * shares outstanding) valuation for public companies is, anyway.
The present valuation isn't as important as intrinsic value if you're talking about the long term. Of course the valuation is a multiple of its trading price. With that definition, its worth whatever people are trading shares think its worth. But that's only 3% of the shares.
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.
I remember a documentary on Walmart where someone said they succeeded by realizing that a small percentage from a very large number is still a very large number.
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?
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
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 . . .
Given fb's current position - would it not be incredibly stupid to NOT do everything possible to continue their growth and try to become more widespread as a necessary layer of the internet?
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.
Of course Facebook is not worth $33bil. Fact: The Facebook engagement numbers for users suck. The data is inflated. That all is fact BUT forget that. Apple shares cost $6 per dollar of revenue. At the same valuation Facebook is worth $9bil. Would you really pay $25 per dollar of Facebook revenue knowing in 2-3 years they could be the next Myspace? They sell nothing. They are actually the Seinfeld of Networks. No loyalty. Nothing preventing anyone from jumping ship. If you think I am wrong people invested way more in their Myspace experience...photos, blogs, video, tricked out pages etc. And then just left. Gone. Bye. See ya.
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.
"The cynic knows the price of everything and the value of nothing." -- Oscar Wilde
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.
The only correction is that in this phrase "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" you confuse customers and users. Facebook users are not their customers. The customers are advertisers, and there ain't 500m of them. So, although their profit hugely depends on the number of users, it's not the only component in the formula.
Actually Joel, your assertion that dhh simply needs to look up valuation in the dictionary is absurd. Valuation is not neatly defined. It's hugely subjective -- especially for private companies.
>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.
For a little more context, a 33B valuation is ~1/5 Google's current market cap, 1/8 Apple's, 1/6 MS's, 1/4 Oracle's, 1/2 Disney's, 1/2 Amazon's, 2x Yahoo's, 15x AOL's, etc.
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.
What facebook is really worth we'll know when they IPO and they sell off a majority portion of the stock. Until then it's anybody's guess.
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'.
"Facebook has been around for seven years. It has 500 million users. If you can’t figure out how to make money off half a billion people in seven years, I’m going to go out on a limb and say you’re unlikely to ever do."
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.
I agree that this valuation is absurd and that Facebook will never really be worth this much. I also really like the 37signals guys and a lot of their opinions.
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.
Facebook’s biggest weakness is that its core value proposition to users is that everybody you know is on it. Any business whose core value proposition is that “everyone is doing it” is essentially a fad. Its success and usage is driven primarily by peer pressure.
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.
The more interesting question is whether facebook will even be around in 5 or 10 years. Look at myspace, huge userbase, grew from almost nothing practically overnight, and relegated to the dust bin almost as fast once facebook came around. The chances of a competitor being able to do the same thing to facebook cannot be ruled out. Indeed, with facebook's api such a competitor would have an easier job of nabbing facebook users than was the case with myspace (join the new site, let the new site import your fb social graph and mirror your feed to facebook automatically up until the day you decide more of your friends are on the new site).
Argue about it all you want, but I will never accept a company's valuation based on second market stock. Only when the stock is publicly trade-able and market forces determine the price to be paid will I accept a valuation.
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?
1. The company has supposedly taken just under a billion dollars in venture capital and small secondary-market sales of stock. So the actual money that has changed hands is just 3% of the total evaluation of the company!"
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[2]
(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[1], 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.
The argument between spolsky and dhh is funny but ultimately they seem to not be talking about the same thing. They are both right, but one is more right than the other.
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.
Thing about making money off facebook is the same thing that happened with trying to make money off myspace.
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.
Apple's also not worth $267B. Based on the current rate that people are selling Apple stock, the demand for Apple stock makes for an equilibrium price such that Apple's market cap is $267B. But if every share of stock were up for sale, they'd have to lower the price to sell it all because there aren't an infinite number of people willing to buy Apple stock at a $267B valuation.
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).
With respect to traditional brick-and-mortar businesses the skills required to successfully build, grow, and manage a small business are different from those required do the same for a big corporation.
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.
Sure it is, it is called Speculation http://en.wikipedia.org/wiki/Speculation Just because there is no real value going on for proper financial analysis behind it yet, doesn't mean prospective valuation couldn't be derived. Obviously, people that invested worked on a model that derived said valuation. Maybe it's a bubble, maybe it's not - but valuation is here. That's how speculative market works, without it there would be no investments.
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).
[+] [-] spolsky|15 years ago|reply
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.
[+] [-] dhh|15 years ago|reply
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!)
[+] [-] timr|15 years ago|reply
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.
[+] [-] cynicalkane|15 years ago|reply
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.
[+] [-] danieldon|15 years ago|reply
[+] [-] ryanwaggoner|15 years ago|reply
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.
[+] [-] CallMeJeffrey|15 years ago|reply
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".
[+] [-] biznickman|15 years ago|reply
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.
[+] [-] m104|15 years ago|reply
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.
[+] [-] BenS|15 years ago|reply
Also, Chicago has lots of smart people, and I agree with you that FB is well positioned to make lots of money.
[+] [-] raheemm|15 years ago|reply
[+] [-] _delirium|15 years ago|reply
[+] [-] earle|15 years ago|reply
[+] [-] seldo|15 years ago|reply
[+] [-] tofumatt|15 years ago|reply
[+] [-] scottymac|15 years ago|reply
Groupon.com Orbitz.com Feedburner.com CareerBuilder.com TicketsNow.com Peapod.com Apartments.com Restaurant.com ShopLocal.com Legacy.com GrubHub.com EveryBlock.com Apoolicious.com Threadless.com Newser.com Songza.com ViewPoints.com Timelines.com SitterCity.com BlockShopper.com CarePages.com SurePayroll.com OneWed.com
...and many other Chicago-based internet companies
Fuck off.
[+] [-] sbaqai|15 years ago|reply
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.
[+] [-] corywilkerson|15 years ago|reply
[+] [-] sachinag|15 years ago|reply
[+] [-] latch|15 years ago|reply
[+] [-] Jeema|15 years ago|reply
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?
[+] [-] indiejade|15 years ago|reply
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 . . .
[+] [-] mrtron|15 years ago|reply
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.
[+] [-] HowieSPM|15 years ago|reply
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.
[+] [-] weezer|15 years ago|reply
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.
[+] [-] pitbear|15 years ago|reply
-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.
[+] [-] vseloved|15 years ago|reply
[+] [-] markdascoli|15 years ago|reply
>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.
md
[+] [-] jfager|15 years ago|reply
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.
[+] [-] jacquesm|15 years ago|reply
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'.
[+] [-] ulf|15 years ago|reply
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.
[+] [-] bherms|15 years ago|reply
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.
[+] [-] marclove|15 years ago|reply
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.
[+] [-] InclinedPlane|15 years ago|reply
[+] [-] zacker|15 years ago|reply
Google's revenue in 2004 was $3.1B: http://bit.ly/bOQZeZ
Facebook's revenue for 2010 is rumored between $1.2B and $2B: http://techcrunch.com/2010/03/03/facebook-revenue-2010/
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.
[+] [-] stevefarnworth|15 years ago|reply
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?
[+] [-] bl4k|15 years ago|reply
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[2]
(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[1], 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:
http://news.ycombinator.com/item?id=1718512
(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.
(Edit: updated)
[1] http://techcrunch.com/2010/06/22/facebook-revenues/
[2] http://www.crunchbase.com/company/facebook
[+] [-] richcollins|15 years ago|reply
Does Facebook approve the sell price? If so then it's likely biased up.
[+] [-] pchristensen|15 years ago|reply
[+] [-] unknown|15 years ago|reply
[deleted]
[+] [-] bambax|15 years ago|reply
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.
[+] [-] dusklight|15 years ago|reply
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.
[+] [-] harryh|15 years ago|reply
[+] [-] paul|15 years ago|reply
[+] [-] points|15 years ago|reply
[+] [-] blakeross|15 years ago|reply
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.
[+] [-] jackowayed|15 years ago|reply
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).
[+] [-] frzl|15 years ago|reply
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.
[+] [-] Keyframe|15 years ago|reply
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).
[+] [-] proee|15 years ago|reply
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.
http://en.wikipedia.org/wiki/Burj_Khalifa
The sad thing is hearing how much our government loosely throws around a billion dollars. 50-Billion here, 100-Billion there... No biggie.