On Facebook’s Valuation

I guess, if I’m ever going to write a post, it should be on this topic.  In addition to having a very timely event, much of Atlanta is home-bound due to a once-in-a-generation snowstorm.

One of the true giants in academic finance, and one who enjoys connecting academic finance with real-world problems, Dr. Aswath Damodaran, has a great blog post on the implied Facebook valuation from the recent Goldman Sachs transaction.  Maybe you’ve heard of it.

Bottom line is that this is, in his view, mainly a transaction to buy a bunch of business.  The argument is very compelling.  If true, over time, Goldman will make far more in fees than it pays for the stock, and it still has 1% Facebook for free.  It looks like a great deal for Goldman.  Not good, GREAT.  If Congress wants to hold an inquiry, they are doing it for the wrong reason (see below for the right reason).  Check this math out.

Goldman trades at about 17.5x earnings, after extraordinary and unusual items (in other words, one time windfalls and/or sh*t hitting the fan, such as being fined by the SEC for pushing collateralized debt obligations on investors).  They paid $500 MM in cash.  They clear a a net margin of over 25%, after taxes. (Being an investment banker is very lucrative but you pretty much have to sell your soul to be successful at that level in the industry – but at least your soul gets a  great price).   If they get $125 MM in fees (the IPO alone is worth much more than that), and they clear $37.5 MM in after-tax profit from those fees, they add $656.25 MM in market cap.  Even if all that is market neutral, they still have 1% of Facebook.

The transaction also evokes some other relevant observations.  First, it underscores the myth that ” a business is worth what someone is willing to pay”.  Maybe you think Facebook could turn around and be acquired for $50 billion.  I don’t.  In fact, what happens when/if the IPO implies a valuation of less than $50 billion?  You got some ‘splainin’ to do, Lucy.

Second, it underscores the importance of how value is defined.  This investment did not occur under conditions that meet a commonly-held understanding of fair value or fair market value.  Typically, under those standards require that that valuation assumes a purchase/sale in which the seller/purchaser have no particular, nonfinancial motive to enter the transaction.  Obviously not the case here.  So don’t tell me your startup could someday get a Facebook valuation. 

Third, I’m led to ponder if there is an antitrust discussion to be had.  Can a large bank go on a spending spree to lock up plum clients by buying their equity on sweetheart terms?  Few people are crying about investment bankers getting locked out of deal but more importantly, you’re not getting anywhere near Facebook’s IPO unless you’re a Goldman client.  I’m not sure that’s good for the capital markets.

Finally, it underscores the danger of relying on implied valuations from past transactions to value a company.  One transaction is that – just a transaction.  You often don’t know the fact behind each transaction.  Transactions also take place between human beings and human beings, even very smart, well-dressed ones, make mistakes – often colossal ones.  If you don’t believe me, Google the following combinations (Nolan Bushnell, Atari 400); (Cerberus Capital, Chrysler); (The Coca-Cola Company, New Coke); (Apple Board of Directors, John Scully); (Dan Snyder, Albert Haynesworth);   Maybe on average, the fleecing goes both ways and nulls out, but on one deal, there’s a good chance someone one and someone lost – even if that won’t be known for 5 years).

Thanks to Dr. Damodaran for enlightening us on this transaction.  I don’t want to steal his thunder; but rather build on his analysis to share some information on how valuation  and M&A intersect.

Leave a Reply

Your email address will not be published. Required fields are marked *