Forbes is reporting that Facebook’s Zuckerberg is now richer than the Google’s Sergey and Larry. How did that happen? By using the most naive form of financial extrapolation and calling it fact.
Here’s how the financial alchemy works: GSV Capital spent $6.5 million to buy 225,000 shares at ~$30/share. That amounts to buying about 0.01% of Facebook. They purchased these shares at a 40% premium over the last big valuation that put Facebook to be worth $50 billion.
So if you extrapolate that the premium paid for 0.01% of the company is the same premium someone else would pay for 100% of the company, you get that Facebook is now worth $70 billion. So the relatively modest investment of $6.5M snowballs into a $20 billion creation of “wealth”. That’s a 3076 wealth leverage! Put one dollar in, get $3,076 out.
Now anyone with an iota of critical thinking would perhaps question whether a stock purchase of 0.01% is representative for the worth of the company at large, but not Forbes. They simply accept this fantasy 1:3000 transformation as fact and serves it up as the foundation of an article that then goes on to place Zuckerberg as the 3rd riches techie in the world.
That is grossly irresponsible financial reporting. But hey, Forbes is on a roll these days.
Unfortunately, it’s not exactly an isolated case either. Remember the cover of BusinessWeek from 2006? It had a happy Kevin Rose on the cover with the headline: “How This Kid Made $60 Million In 18 Months”. Anyone wants to ask Kevin how much of that paper money he got to keep as Digg tanked? I’ll bet you a buck that it wasn’t $60 million — or anything close to that.
We used the same math to value 37signals at $100 billion in 2009. It was meant as a joke, but I guess Forbes thought of it as a blueprint.
Jay Carusoon 29 Jun 11
I remember that Newsweek cover story. I would listen to Kevin TwitTv and even he said he had no idea how they came up with that figure because even when Digg was the most popular thing on the Internet, he didn’t have that kind of money.
Joshua Blankenshipon 29 Jun 11
“Wizards of Bullshit” is my new favorite fictitious band name.
Martinon 29 Jun 11
You’re right that this is kinda weird to say the company is worth $70B because someone bought 0.01% of the company for $6.5M, but on the other hand, they’re expected to IPO early next year at a $100B valuation.
Also, in the forbes article, they do say it’s a “paper fortune”, meaning it could be harder to cash it all!
Ryan Heneiseon 29 Jun 11
This is great – I just did the math, and I’m a lot richer than I thought!
Anonymous Cowardon 29 Jun 11
Why would anyone buy 0.01% for 6.5 Million for more than they were worth if they were the only shared they owned? Do they own other shares?
Don 29 Jun 11
It could be a shill as part of the IPO’s PR/marketing plan.
Another cowardon 29 Jun 11
I just sold 0.000000001% of my firm to my Mom for a dollar and now i’m a multi-millionaire.
She flipped it to my Dad for 10 bucks and, easy as that, I’m a billionaire.
Lucianoon 29 Jun 11
You make a fair point, but keep in mind that even very liquid stocks only turn over less than 1% a day. Google for example trades about 2.5m shares vs. 322m total.
What percentage of shares needs to trade for you to consider the implied mkt cap valid?
DHHon 29 Jun 11
Luciano, in a publicly traded company like Google, you have a true market with lots of participants. 2/3s of Google’s stock is out in the open, so you’re never going to see these insane 40% markups over the last trade.
Say Google stock is $100. If a buyer wants to buy 10 shares, he might buy the first 5 for $100, then the next three for $101, then the last two for $102. He’s not going to come in and just say give me 10 shares for $140. But that’s what he has to do in these second market offerings because the float is tiny. So in turn, the transaction is not going to be representative of what the whole market is like.
Adrian Scotton 29 Jun 11
DHH, I’d like to see you answer Luciano’s Q:”What percentage of shares needs to trade for you to consider the implied mkt cap valid?”
Also in terms of “you’re never going to see these insane 40% markups over the last trade”... actually there is a time when you see this happen—when an M&A deal occurs and another company buys a public company, speaking of valuation of a whole company…
So, imho, the validity of the post is rather weak… and Martin’s point “on the other hand, they’re expected to IPO early next year at a $100B valuation” is rather relevant.
DHHon 29 Jun 11
Adrian, the acquisition case is exactly one where the markup can make perfect sense. There’s no extrapolation. The acquirer is paying for the whole thing, so obviously that’s the value. The further you get away from that, the more fishy things become.
I’d consider the market cap of any stock that’s publicly listed, and thus completely liquid, and has a reasonable number of their shares listed (25%+?) to be valid on the basis of the last trade.
I consider the constrained release of companies like LinkedIn who put just 10% of the shares up for sale to be a form of the same scam, albeit from a different angle.
Heh, the operative word is “expected”. If I sell 0.00001% of my company for a dollar and EXPECT that those shares will be worth $2 next year, then all this is a legit market cap? Come on now.
Razvanon 29 Jun 11
this is a universal issue with journalists who write about everything and have to come up with some attention grabbing headline
Steven Lessardon 29 Jun 11
I think the focus on percentage of outsanding shares is misplaced. Shares of Facebook trade in a very illiquid market and therefore pricing of it simply impossible. The fact that Google is traded on the NYSE allows buying and selling of shares without much price flucuations (given these trades are not extreme block trades).
Personally, a percentage outstanding for implied market cap calls for 75% outstanding.
Ken Hillyeron 29 Jun 11
Great headline, but I was expecting a little more meat. If you had some proof as to insiders holding preferred shares with super participating liquidation preferences, the argument would be much stronger.
Given that Facebook is among the top traded stocks on SecondMarket (et al) actually proves there is a(n at least semi-) liquid market for the stock. Just because the average investor cannot buy Facebook through Edward Jones does not make the stock entirely illiquid.
The primary valuation terms affecting this calculation are (il)liquidity discount, control premium, and uncertainty in future earnings.
A valuation professional could make a reasonable case that the liquidity discount is already priced in to the Facebook private market sales, which would imply that the enterprise value is actually higher. Furthermore, a control premium could apply to shareholders that are able to influence direction of the company, which would definitely apply to Zuck’s holdings.
You do have them on uncertainty in future earnings.
Case in point – MySpace selling for ~$40MM
(yes, I just compared FB to MySpace)
zatoon 29 Jun 11
The Internet is a propaganda tool. Powerful people want Facebook to win it all.
Seanon 29 Jun 11
Slowly people are begining to realize that economists have more in common with fortune tellers than scientists.
Salimon 29 Jun 11
I don’t disagree with you that the valuation is an extrapolation and that it won’t be accurate.
But, what do you mean by the “3076 wealth leverage”. What I think you mean is that Zuckerberg owns 30.76% of Facebook.
$6.5m/0.01% = $65bn. His $20bn worth comes from the 30.76% he owns ($20bn/$65bn = 30.76%).
No one is saying that GSV’s investment is worth $20bn. Their investment is $6.5m and the shares they own are worth $6.5m based on what the invested. They aren’t worth $20bn ($6.5m x 3076).
Salimon 29 Jun 11
Since you deleted my comment, can you tell me how you calculate the “3076 wealth leverage”? Who has put in a dollar and multiplied it 3076 times?
Waldo Peppermanon 29 Jun 11
The last price paid for a stock is what is generally considered the value of the stock.
It doesn’t matter if a security has been trading at, say 25 dollars all day long, if one person buys one share at 30 at the end of the day, the share price is printed as 30 dollars.
GSV Capital paid that price, then that’s the price. Until someone else comes along, it doesn’t matter. The market will decide.
DHHon 29 Jun 11
Salim, your comment is showing up here. The 3076x comes from the fact that the $6.5M investment at a 40% premium supposed raised the value of the entire company by 40% or $20 billion. So $20B / $6.5M = 3076.
Waldo, for a publicly traded company with plenty of float and liquidity, sure. This is not that.
blackberry whiteon 29 Jun 11
it amazes me how people value companies that dont really “make” anything
Kenny Williamson 29 Jun 11
I like to keep things simple. Just like Linkedin I will wait for the profits and solid revenue model. Facebook has a better shot at it than Linkedin in my opinion, but neither is Google, or 37Signals (Cheap suckup yes).
Jonathan Payneon 29 Jun 11
Um, it was GSV Capital who valued facebook at AT LEAST $70B. Why else would they invest if not to hope to grow their money?
GregTon 29 Jun 11
The last two paragraphs of the article directly rebut DHH’s points (and actually link to this post).
Forbes is just promoting themselves (with exaggeration and hubris) the same way 37S and everyone else does. If you swallow ANY of them at face value … well, you’re very naive.
I don’t really like it either but I don’t really care so much. I’m not so sure why DHH gets so worked up about these things.
Martyon 29 Jun 11
I found this article to be as sensational and content-less as the original. Perhaps more-so; at least the Forbes article included some prior unknown news (the GSV transaction).
Bakasuraon 29 Jun 11
Awesome post. I wonder how much money does he have actually in the bank account :P
Does anyone know ?
Kenny "Dead Serious"on 29 Jun 11
This is great.
I read that Forbes article last night and I found it to be asinine. There was also a really bad typo at the bottom. I understand minor editing errors occur, but to publish such a crap article making such obtuse generalizations about the value of a company based off of a transaction involving less than 1% of the company plus that typo …. it made me want to barf.
Dave Bloomon 29 Jun 11
Guys like Bill Gates and Larry Page have so much money, but they still sound like Kermit.
I can’t imagine Zuckerberg charming a girl or being soulful, down to earth, or cool in any particular way.
His passion is admirable. But I wouldn’t trade places with the guy for double his money. I ride coach.
David Semeriaon 29 Jun 11
I agreed with your last rant over FB’s valuation (when you got into a row with @spolsky) – but this time it’s different…
All the recent trades in FB have been at around a $70bn valuation.
We’re talking multiple trades and multiple counterparties (as opposed to the situation the first time round). That’s the key difference.
Even if the trades add up to a small percentage of the total shares, that’s how the markets work.
This time you’re wrong. Sorry.
Ethan Stockon 29 Jun 11
David, do you believe in public markets? Do you believe in the concept of “market cap”? Do you believe that Google’s valuation is “real”? It sure doesn’t seem like you do. Public market caps are set second by second based on the exchange of some tiny fraction of shares, far less than .01%. This is true of Google, or General Electric, or Exxon, or any hard asset company that you care to name. I understand illiquidity and I understand thin floats. Both of those are valid issues WRT the Facebook transaction. But your raging fury isn’t directed at either of these; it’s directed at the very basic concept by which ALL public companies are valued, which is most recent transaction share price * number of shares outstanding = valuation.
DHHon 30 Jun 11
Ethan, Facebook is not a public company. That’s the whole point. When there’s a tiny float and some company picks up a 0.01% position at a massive premium, then using public-company extrapolations about the value of the company makes no sense.
David Semeriaon 30 Jun 11
@ddh – a “massive premium” to what, exactly? QED.
Ben Jefferyon 30 Jun 11
Interesting point, all this high valuation is too similar to a pyramid scheme – as long as people keep paying higher prices, it all works but what happens when it stops?
Jaret Manuelon 30 Jun 11
Are you telling me the media doesn’t tell the truth anymore? (Kidding).
You are bang on. Does the public understand the financial performance & underpinning’s of Facebook? If no, then you might as well go smoke some crack with puff the magic dragon or gamble in a back ally. Pure speculation of Klondike proportions.
It is safe to say Zuck can afford to zap some KD in his microwave but his net worth is largely subjective to the public.
Beckon 30 Jun 11
Although I think DHH comments are not flawless, I can see the ground and roots. There would be plenty of people to argue against DHH about relative reasonableness of pre-IPO evaluation.
But the fact is, there are too many big forces around seeking to do both – write and play the scenario themselves.
Financial markets existence has played their role in history and essentially that role is dead, because the watchdogs (SEC in US, or SESC in Japan) are simply paralyzed.
The modern world doesn’t already need financial markets to evaluate your business. If the business is worthwhile, there would be enough people and institutions to invest even without stock markets.
Pre-IPO evaluation became = Greed-o-meter and Market Cap thing is just an illusion
Gary Buryon 30 Jun 11
In valuation normally a minority share is valued less than a majority share. Which means, if someone is willing to pay a 40% premium on a minority maybe they’d be willing to pay say 60% for a majority share, which would value facebook even more.
Having said that, I think valuing the entire company based on 1 transaction for 0.01% holding is crap.
It’s just a reflection of the poor journalism we see on a day to day basis.
TJon 30 Jun 11
The sad thing is that so many people believe these BS valuations, because it’s reported via Forbes.
christopher brunoon 01 Jul 11
The difference between using the stock price in market cap calculatons and doing what Forbes did is this: the stock price emerges from the interaction of supply and demand in a competitive market with many agents. Aside from the bubbles that come and go, in the long run the stock price is best estimate of fundamental value given the uncertainty of future corporate income.
The Forbes method is a back of the envelope calcuation based on one small transaction from one agent at one point in time. Maybe their valuation is rational, but it is hardly a market consensus.
christopher brunoon 01 Jul 11
Also, who says you have to base a valuation on the last traded price? With a plethora of trading time series you can construct more sophisticated valuation models. But thats the point..there is a lot of data for publically traded companies to help make realistic valuations….Forbes however is making a bold valuation on not much using a crude method.
fairytaleon 01 Jul 11
sometimes it’s just a trend because of the development of the sciety. and what you said is just your speculation and not affaimative. criminal lawyer Toronto
Ikaboton 01 Jul 11
Market capitalisation is only one measure of the value of a company. It’s the speculation/bubble measure based on (often naive) opinion. At least with a publicly traded company, that opinion can be based on quarterly results.
A more valid measure is the discounted present value of expected future earnings. This is the P/E ratio measure and while some prediction of the future (future earnings) is required, its basis is more reliable than what you think you can sell a tulip for next month or a year from now.
When the first value is orders of magnitude higher than the second value, we have reason for pause.
Al Pittampallion 01 Jul 11
There’s a lot of shady dealings going on in valuations across the board. It’s become a hotbed of misrepresentation and it’s really becoming irresponsible. Thanks for bringing attention to this, David.
albsureon 01 Jul 11
Second market valuations are essentially a pyramid scheme. You have a limited amount of investors with a vested interest in keeping a stock price high. So they all trade on that basis. Its completely artificial.
You could do that with anything… paper cups.. plastic spoons, chocolate bars.. The “thing” itself doesn’t have to have a real value in a limited market that colludes to keep the “thing” high. All that matters is a consensus view amongst a few people (i.e. Silicon Valley VC’s) and “boom” you have a highly valued company.
As with all pyramid schemes the fewer people in on the scam the better. The more people join a scheme the less people believe they are going to get paid. Its a bit like pass the parcel, the longer the music gets played the more jittery everyone gets about holding the parcel.
Thats why an IPO is the truth teller. An IPO with say 50% of your stock dillutes the pyramid. This produces less bullshit and more reality. Eventually the stock goes to its real value because its impossible to collude between thousands of people who hold your stock. The more stock holders generally the more accurate your stock price is.
Stock prices usually ended up being relative to earnings per share (P/E).. i.e. how much money the company actually makes. Facebook, Linkedin et al.. are all on some bullshit because everyone knows that they dont actually make anything like the money they are valued at and are unlikely to do that in the long run.
But there is vested interest by the starters of the pyramid schemes (the VC’s) to get the most money out of their investments before everyone finds out that they arent worth anything like their secondary valuations.
Which is why intelligent magazines like Forbes etc.. publish this utter bollocks about Zuckerburg and his billionaire status. Its all hype, to keep the dream alive enough for everyone to get there dough and split.
If you dont believe me, ask AOL, Myspace.. Same shit, different day..
Derickon 01 Jul 11
What other method do you propose people use to value a business?
Vinicius DhomCarvalhoon 02 Jul 11
Thanks the Knight Templar for that!
Ianon 03 Jul 11
What is the real purpose of this post?
aGalon 06 Jul 11
They purchased these shares at a 40% premium over the last big valuation that put Facebook to be worth $50 billion.
Ikaboton 06 Jul 11
@Derick : I know you asked 37signals, so I’m probably speaking out of turn here, but don’t you think that using the discounted present value of expected future earnings would be a good metric?
This discussion is closed.