Mark Zuckerberg Still A Terrible Banking Analyst, Not Into Precision

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Happy Facebook filed an amended S-1 day! Or something. Anyway Facebook filed an amended S-1, which will change everything you thought you knew about Instagram. Like:

In April 2012, we entered into an agreement to acquire Instagram, Inc., which has built a mobile phone-based photo-sharing service, for approximately 23 million shares of our common stock and $300 million in cash. Following the closing of this acquisition, we plan to maintain Instagram’s products as independent mobile applications to enhance our photos product offerings and to enable users to increase their levels of mobile engagement and photo sharing. This acquisition is subject to customary closing conditions, including the expiration or early termination of all applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as amended (HSR), and is currently expected to close in the second quarter of 2012. We have agreed to pay Instagram a $200 million termination fee if governmental authorities permanently enjoin or otherwise prevent the completion of the merger or if either party terminates the agreement after December 10, 2012.

So, first: is anyone else sort of tickled that there's a $200mm termination fee for failure to get through antitrust review? I am no antitrust expert and I know that HSR filings are automatically required if your purchase is over $68.2mm but I feel like I'd be betting on this one getting through antitrust review, no? These are, after all, two companies that give away their products? Perhaps I do not understand antitrust and/or Instagram; either is quite plausible.

But the fun in this is of course in the valuation, and here I feel like I need to walk back my praise of Mark Zuckerberg's dabbling in paradox when he did his valuation analysis. Dan Primack explains:

Facebook is officially valuing itself at $75 billion. Here's how the math works: Facebook recently acquired mobile photo-sharing site Instagram, announcing that the deal was worth approximately $1 billion. Today it provided more specifics, saying that the deal included $300 million in cash and approximately 23 million shares of common stock. That means the stock is valued at around $700 million, or $30.43 per share. Based on the number of shares outstanding, that works out to a valuation of approximately $75 billion.

So, mehhhhh, kind of. $30.43 per share, huh? Significant digits are not like CDOs; they cannot be manufactured from thin air but must be mined from the ground with hard work and heavy equipment. Facebook's "approximately $1 billion" in its announcement of the deal means a valuation of oh let's say $8.70 to $52.17 per share. $30.43 is indeed the midpoint of that range.* But you can bet that everyone at Facebook and Instagram was thinking that the deal was worth $1.2 to $1.3bn or so, because Facebook shares are Level 1 assets** and that was their price in traded markets.

Here is what Facebook announcing that 23mm shares + $300mm cash = "approximately $1 billion" probably did not mean:
(1) Facebook thinks it is worth $30 a share
(2) Facebook thinks that the IPO will price at $30 a share
(3) Instagram thinks either of those things

Here is what it probably meant:
(1) Some 20somethings got enormously rich and were like "hey could you say a billion dollars in the press release? It sounds cool."

Obviously there was some negotiating value to Facebook in talking up a higher valuation - DealBook reported last week that the $40+ per share secondary-market transactions helped move Instagram down from its $2bn initial request - and, I suppose, there was some value to Facebook in talking a lower valuation (no whining / seller's remorse, fraud claims, etc. - DealBook notes that Facebook never pushed the $40+ price in negotiations). But there is a much higher value to Facebook in avoiding any sort of valuation talk around an acquisition of a private company with no revenues for <1% of its stock: because its valuation will be what the stock market decides it will be, and Facebook and its bankers want the maximum possible flexibility to argue their case when they go on the road with the IPO. Facts like a $44.10 private-market print are broadly supportive of that case. Facts like "Facebook decided that it was worth $X and told some other guys that in a negotiation where the valuation was basically irrelevant because the numbers were all kind of made up anyway" are less useful: that's unlikely to push anyone to a higher price, but could be a talking point for an investor arguing for a lower price.

If I were Facebook's banker or lawyer, I might have suggested a press release saying more like "we bought Instagram for 23mm shares and $300mm in cash" and less like "oh and btw here is what that package is worth on the following assumptions which we totally believe and will use in pricing our IPO." But the deal got done more or less without bankers and lawyers, and of course if I were an Instagrammer I would very much want a $1bn print to send to my grandparents. I suppose they compromised on a press release saying "approximately $1 billion," which lets Instagram claim the magic 10 digits while also being vague enough that no one would try to use it to pin Facebook down to a valuation. Except that, y'know, this is Facebook, so everyonedid.

Facebook values itself at $75 billion [Term Sheet]
That $1B for Instagram? It’s 23M Shares of Facebook + $300M in Cash [AllThingsD]
Facebook S-1/A [EDGAR]

* Random semi-story: Once a client wanted me to provide a point estimate of a thing for Valuation Purposes, and for Liability Reasons I wanted to provide only a range of possible values, and we compromised by me providing a range and saying "$XX is the midpoint of that range," which, it was! Math is hard.

** Are they? Is SharesPost an "active market" for valuation purposes? Anyway, they're metaphorically Level 1 assets at least.

Related

Mark Zuckerberg Will Never Make It As A Banking Analyst

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.*

What If Mark Zuckerberg Wore A 3-Piece Suit And A Monocle To The Facebook Roadshow?

What if Mark Zuckerberg wore cutoff jean shorts and a mesh Hawaii 69 football jersey to the Facebook roadshow? What if Mark Zuckerberg wore a Mr. Peanut costume to the Facebook roadshow? What if Mark Zuckerberg wore a tuxedo tee-shirt to the Facebook roadshow? What if Mark Zuckerberg dressed as Robocop for the IPO roadshow? What if Mark Zuckerberg wore Crocs to the Facebook roadshow? What if Mark Zuckerberg entered the roadshow as a member of the Lollipop Guild? What if Mark Zuckerberg wore Capri pants to the Facebook roadshow? What if Mark Zuckerberg wore a wetsuit to the Facebook roadshow? What if Mark Zuckerberg wore a Lacoste polo with an argyle sweater wrapped around his neck to the Facebook roadshow? What if Mark Zuckerberg wore the Hannibal Lechter mask from Silence of the Lambs to the Facebook roadshow? Would things have turned out differently? If Zuckerberg had left the hoodie at home? One guy says yes. "I felt that had Mr. Zuckerberg worn a jacket instead of a hoodie (showing them that he respected them enough to "dress up"), he would have made a statement to them that he cares about their needs, and will act in their best interest. He chose not to make that statement, and the current share price demonstrates that investors have chosen not to support Facebook shares. All of this is iterative. Had Facebook issued 10 million shares instead of 421 million, the stock would probably be much higher. However, had Mr. Zuckerberg worn a jacket and reassured investors that he is aligned with their expectations, perhaps more people would be stepping in to buy now." So...yeah.