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.*
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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.

Related

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.

Facebook Will Take Free Money From Banks But Don't Expect It To Show Any Gratitude

The Wall Street Journal today discovered that universal banks that lend money to companies for cheap tend to want investment banking business in return for that lending and I guess that's a scandal: As the market for technology IPOs revs up and the biggest banks seek to capitalize on the size of their balance sheets, the practice of selecting underwriters that also provided loans is coming under focus, spurred by Facebook's IPO process. Critics of the practice say the choices aren't accidental and reflect the "you-scratch-my-back-I-scratch-yours" way that Wall Street works. Bankers, for their part, say they aren't allowed to make loans on the condition that they receive other business, but borrowers can use the loans as a factor in choosing underwriters. Some bankers say that lending is just one of the many services they offer companies. At Facebook, the credit line played a role in the batting order for underwriters, said a banker who worked on an underwriting pitch to the company. When I was young and naive and pitching for underwriting business against banks that did lots of lending, I always thought that banks "aren't allowed to make loans on the condition that they receive other business, but borrowers can use the loans as a factor in choosing underwriters" thing was ripe for a scandal. I still sort of think that: I just do not believe that no client coverage banker has ever said "we'll be in your credit facility but only if you promise us underwriting or M&A business." (Some people agree with me!) And, as the Journal notes, that would be a criminal violation of the antitrust laws, which is unspeakably weird but there you go. But if you ask a banker who has been carefully and recently briefed on anti-tying regulations, he will probably tell you something like "we don't demand underwriting business to provide a loan. Companies demand loans to get underwriting business." And, as the Journal says, that's not illegal.

After The STOCK Act It Will Still Be Legal To Trade On Congressional Inside Information*

Here's a sort of touching monologue from David Einhorn's call with Punch: If you’ve done the analysis, and come to the conclusion that on it’s own, the company is not going to make it, it makes all of the sense in the world to raise equity at whatever the price is, so that you can know that the company, you know, is – is going to make it. Now, what that brings to my mind though is, you know, obviously we haven’t done your analysis, we haven’t done -- signed an NDA; I don’t know that we’re going to sign an NDA, because we prefer to just remain investors, but from my perspective, and I’ll be just straight up with you, is that gives a lot of signalling value. And the signalling value that comes from figuring out the company has figured out that it’s not going to make it on it’s own is that we’ve just grossly misassessed the -- you know what’s going on here. And -- and that, that will cause us to have to just reconsider what we’re doing, which is not the end of the world to you. You will continue on even if we don’t continue on with you. You could sort of see why the FSA read that to mean that he was insider trading. Like ... (1) You have told me something with signalling value. Sorry - "a lot of signalling value." (2) I will now act on that signal. (3) Don't be mad. "Signalling value" sure sounds like it means "material nonpublic information," doesn't it? Now as we've discussed before, trading on that information would not be enough to make Einhorn guilty of insider trading in the US, though maybe it wouldn't be exactly a great idea here either. Why? Because in our weird but sort of sensible insider trading laws, it's just not illegal to trade on material nonpublic information. It's only illegal to trade based on material nonpublic information that was obtained in violation of some sort of duty of confidence. Since Einhorn didn't sign an NDA, he had no duty of confidence. And since the Punch CEO and bankers weren't tipping him for nefarious purposes, but were instead sounding him out on the company's behalf as a shareholder and potential investor in a new capital raise, they weren't breaching their duty of confidence. You could quibble with the details of that but it's basically the law here. In England not so much. That also seems to be the law for our friends in Congress, who recently passed a law making it illegal for them to insider trade, which is worrying some people who make their living from trading on Congressional inside information: