The best part of this morning’s Journal story about Facebook buying Instagram is clearly Mark Zuckerberg’s valuation approach, which I hope will be taught in future M&A banker training sessions:
Now, however, Mr. [Instagram CEO Kevin] Systrom found himself in Mr. Zuckerberg’s house asking $2 billion for Instagram. Mr. Zuckerberg suggested looking at the value of Instagram as a percentage of the value of Facebook, people familiar with the matter said.
Mr. Zuckerberg, who planned to pay for Instagram mostly with stock, asked Mr. Systrom what he thought Facebook would be worth, the people said. If he believed Facebook would one day be worth as much as a company like Google at $200 billion or more, then the equivalent of 1% of Facebook would be sufficient to meet his price, Mr. Zuckerberg told Mr. Systrom, the people said.
It was as good an argument as any, considering that traditional ways of valuing a company — by its cash flow, or the sum of its parts — are ineffective when that company makes only one product and gives it away free.
“It was as good an argument as any” given that it is a TERRIBLE ARGUMENT. Here it is as best I can make out:
(1) Instagram is worth $2bn
(2) Facebook is worth $100bn
(3) At some point in the future Facebook will be worth $200bn, I guess
(4) Therefore $100bn = $200bn
(5) Therefore $1bn = $2bn
(6) Therefore you should accept $1bn because it’s $2bn
B+ students in those future M&A banker training sessions will object to using a zero discount rate (for equity!) and/or the failure to probability-weight Facebook’s future $200bn valuation; the more advanced may notice that this argument proves that 1 = 2 and is thus a reductio ad absurdum of itself. These numbers are all sort of imaginary anyway so I will concede that this “was as good an argument as any” so long as we recognize that it is also literally the worst argument that it is possible for anyone to make about anything.*
ANYWAY. Blahbitty blah blah Zuckerberg is a terrible evil cowboy who is not only out to ignore his shareholders but also his board and he’s the evillest CEO that ever did CEO. I dunno. I could make the case that focusing on growing the business with smart acquisitions is a better use of CEO time than bopping around the IPO pre-pre-roadshow; I could also make the case that if he got Instagram to swallow the above argument then Zuckerberg is a ninja level negotiator and that’s worth something. And even if you disagree with all that Zuck has to be at worst the second evillest CEO that ever did CEO because Systrom also negotiated without his board and he was selling the whole darn company.
The criticism of Zuckerberg slighting his board is probably even less compelling than the criticism of him slighting his prospective future shareholders. Those future shareholders after all in theory have something that he wants, viz. their money, though he doesn’t seem to want it all that much. The board are just his employees as the majority shareholder (while also being his employers as CEO, circle of life), so the fact that they were “told, not consulted” seems about right. If they’d said no he could I suppose have fired them.**
Still this does seem like a romantic last bit of freedom before being subjected to the … relentless pointless nagging of the public markets. Zuckerberg didn’t do this deal without input from his board and (current) shareholders because he hates them; he did it that way because he knows them and shares an understanding of Facebook’s strategy with them. They’re his VCs and employees and big investors. Sure if they object to his approach there’s not much they can do about it, but there’s one thing that they could do and don’t, and that’s throw huge public tantrums about how mad they are.
Contrast oh, I don’t know, Citi. Citi’s shareholders really can’t do anything at all about Vikram Pandit’s pay – except very publicly and embarrassingly complain (and maybe file kind of frivolous lawsuits). But they’re doing exactly that. The luxury that Zuckerberg will lose by going public isn’t the freedom to act without consulting his shareholders and directors; it’s the warm fuzzy feeling of confidence that they’re all on the same page. Which is not nothing.
In Facebook Deal, Board Was All But Out of Picture [WSJ]
Did Facebook’s Zuckerberg just have a Van Gorkom moment? [Professor Bainbridge]
* I mean, I kid, it was probably more nuanced than that. Also the Journal is quite right about the inapplicability of other valuation metrics given that Instagram has no revenue; you could argue that while Zuck talked Systrom into believing that 2 = 1, Systrom talked Zuck into believing that 0 = 2, which is twice (?) as impressive.
** Meh, not really, there are voting agreements and charter provisions covering director elections that terminate on IPO so he’s stuck with some of them for a while longer.