For the two of you who were on the beach sipping mojitos and haven't heard yet, Facebook (FB) recently offered to buy out Snapchat for $3 billion. Snapchat's two co-founders, with all the wisdom garnered from their 6 years (combined) as adults of drinking age, turned down the deal.
Why? They seem to think the company is worth substantially more than that. I would question their judgment, but I'm not really in a place to do so: after all, in today's market, revenue-less companies command a valuation premium. We must ask the question once again: why? The prevailing logic seems to be this: for a company with zero financial history, pie-in-the-sky projection #1 of $100M first-year revenues and 100% CAGR sounds just as reasonable as pie-in-the-sky projection #2 of $500M first-year revenues and 200% CAGR. When all the numbers might as well be pulled out of a hat, why not pick the ones which make you worth the most?
There are many lessons to be learned from this. For example, for any college students out there who are reading this: if you start a company that makes no money and somebody offers you never-work-again-and-buy-a-fleet-of-Lamborghinis money, you should take it and go start another company to optimize your risk/reward. More on the topic of investing, the implications for Facebook are so obvious that they almost don't bear mentioning: Facebook is clearly trying to re-engage with teens at any/all costs, and when all's said and done, they'll probably burn through another few billion on acquisitions of companies with immaterial revenue. Whether FB can monetize its existing platform to an extent great enough to justify its current monetization remains to be seen; the challenge gets more difficult if they spend all the cash they generate on even more to-be-monetized platforms.
The implications beyond Facebook, however, are much more interesting to me. They are as follows:
- If you're confused about valuations in the social media sector, this clip should explain the secret proprietary analytical techniques that are being used. Essentially, to co-opt a Silicon Valley buzzword, it's 1999 "two point oh". 175x 2-year forward profits? Why not!
- Don't chase momo unless you know what you're doing. If you're a sophisticated investor with a well-substantiated thesis for why a specific "social" company is going to the moon and beyond, then that's a decision. But if you're one of the several people who've asked me "hey, I saw Twitter went public and is going up really fast, should I buy some?" Then... the answer is no, you probably shouldn't.
- ... the above sounds like a good call to short, right? I mean, we all know how Paine Webber's call worked out. But I also know multiple smart investors who ate it. Yes, I think many valuations in the space are absurd, but I've come to the conclusion that shorting is more dangerous than I feel comfortable with. There are too many risks. One is that valuations keep rising longer than I can remain solvent. As irrational as they may be, look around you - do you see any catalysts that will lead to a slowdown? I don't. I thought last year was the end of it, with FB and Zynga (ZNGA) and Groupon (GRPN) all taking it on the chin, but apparently investors caught a second wind. As if regular market irrationality wasn't bad enough, we also have an 800-lb. gorilla in the room that is apparently willing to spend any amount of money to acquire anything with teen exposure. I think acquisition tail risk is quite high.
- As a brief caveat to the above, the exceedingly sharp Akram's Razor absolutely nailed the Chegg (CHGG) IPO, or so it would seem after a steep decline in the first few days of trading. Granted, not exactly the same sector, but close enough. The difference, perhaps, is that Chegg has some financial history. The companies receiving sky-high valuations either promised to make money in the future or don't have any plans to make money at all. Both scenarios allow investors to extrapolate whatever numbers they like. There's actually a penalty to having mediocre (or worse, failed) monetization efforts.
- Lest the eyebrow-raising valuations in the social media space and the somewhat unattractive valuations on many other well-known companies discourage you too much, don't worry, there are opportunities out there. There always are. One of my favorite stories to tell people is how Donald Yacktman made a boatload by snapping up small-cap techs on the cheap in the late '90s when everyone else was buying anything .com. If the pitcher's so nervous about the superstar hitter that he's always staring in that direction, the guy on first base might just steal second while nobody's looking. Moral of the story: if everyone's looking in one direction, look in the other direction and you might find an opportunity.
- Where exactly can you find these opportunities? Consider looking into "enablers" or other companies that will benefit a step (or two, or three) removed from the trend. In other words, buy the guys who make shovels. I've previously highlighted Intel as a company that I like as a beneficiary of the clear and obvious trends in computing and data usage. I don't know whether that usage will be via Android or iOS or SnapChat or Facebook or Firefox or SAP (SAP) or Salesforce (CRM), but I do know that there are more and more people and companies using more and more data every day. Intel and a good chunk of other tech hardware companies are pretty well-positioned to benefit from those trends, and their valuations range from "undemanding" to "cheap". This is just one example - plenty of other opportunities exist. You just have to find them.
That's my take. There are, of course, others. Non-investor friends who are more attuned to social media than I have informed me that SnapChat is, in fact, quite popular, and "probably worth a lot."
It's worth noting that they also said that about Myspace and Farmville, and for those of you who are old enough to remember, Xanga.
So when you hear about the next big thing, take it with a grain of salt. There seems to be a loosely inverse correlation between "number of headlines" and "magnitude of investment opportunity".
Disclaimer: This is solely my opinion, not an investment recommendation or solicitation, and may not represent the views of my employer(s), associates, or other related parties. No guarantees made to accuracy or completeness. I am long INTC and several other tech hardware companies, and may change my position at any time without notification. Please see the full disclaimer in my profile, and do your own due diligence before making any investment.